Marino v. Patriot Rail Company LLC

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
GARY O. MARINO, )
)
Plaintiff, )
)
v. ) C.A. No. 11605-VCL
)
PATRIOT RAIL COMPANY LLC, )
)
Defendant. )
OPINION
Date Submitted: December 9, 2015
Date Decided: February 29, 2016
Philip Trainer, Jr., Toni-Ann Platia, ASHBY & GEDDES, Wilmington, Delaware;
Lawrence J. Hamilton II, Frederick D. Page, Ben Ziggy Williamson, HOLLAND &
KNIGHT LLP, Jacksonville, Florida; Counsel for Plaintiff Gary O. Marino.
John D. Hendershot, Rachel E. Horn, RICHARDS, LAYTON & FINGER, P.A.,
Wilmington, Delaware; Charles Bachman, O‟MELVENY & MYERS LLP, New York,
New York; Counsel for Defendant Patriot Rail Company LLC.
LASTER, Vice Chancellor.
Plaintiff Gary O. Marino seeks advancements of fees and expenses from defendant
Patriot Rail Company LLC (the “Company”). The parties have cross-moved for summary
judgment. Marino‟s motion is granted. The Company‟s motion is denied.
I. FACTUAL BACKGROUND
The facts are drawn from the affidavits and supporting documents that the parties
submitted in connection with their motions for summary judgment. The parties agreed in
their briefs and at oral argument that there were no disputes of material fact that would
affect the outcome. Pursuant to Court of Chancery Rule 56(h), the cross-motions
therefore became “the equivalent of a stipulation for decision on the merits based on the
record submitted with the motions.” Ct. Ch. R. 56(h).
A. Marino And The Company
From 2004 until June 18, 2012, Marino served as Chairman, President, and CEO
of the Company. He indirectly owned 23.75% of its equity. Patriot Rail Holdings LLC
(“Parent”) owned all of the stock of the Company. Patriot Rail LLC (“Grandparent”)
owned all of the member interests of Parent. Patriot Equity LLC (“Great-Grandparent”)
owned 23.75% of the member interests of Grandparent and served as its managing
member. Marino owned 100% of Great-Grandparent.
Marino previously owned another 25.5% of Grandparent, which he held either
directly or through Great-Grandparent. At some point, he transferred those interests to the
Marino Family Dynasty Trust for no consideration. Together, Marino and the Marino
Family Dynasty Trust owned nearly 60% of the member interests in Grandparent
(23.75% + 25.5% = 59.25%).
1
The Company operates short-line and regional freight railroads throughout North
America. The Company remained a Delaware corporation until May 1, 2013, when it
converted into an LLC. The conversion did not affect its liabilities or obligations. See 8
Del. C. § 266(e).
B. The Company’s Involvement With Sierra
Non-party Sierra Railroad Company provides railroad-related services. At various
points, Marino discussed the possibility of the Company acquiring Sierra with Sierra‟s
management team. As part of those discussions, the Company and Sierra entered into a
non-disclosure agreement dated September 29, 2005.
Sierra had a contract with McClellan Business Park to provide rail switching
services (the “Switching Contract”). It was scheduled to expire on February 29, 2008. In
2007, as part of the periodic discussions about a business combination, Sierra provided
the Company with confidential information about the Switching Contract. At the time,
Sierra was negotiating with McClellan to extend the Switching Contract. To reassure
McClellan that Sierra had an industry partner that could back Sierra in fulfilling an
extended agreement, Sierra took Marino and other Company employees to meet with
McClellan representatives.
McClellan decided not to extend the Switching Contract and instead issued a
request for proposals. Both Sierra and the Company submitted bids. In January 2008,
McClellan awarded the contract to the Company.
2
C. The First California Lawsuit
In March 2008, Sierra sued the Company in the United States District Court for
the Eastern District of California (the “California Court”). Sierra‟s complaint included
claims for breach of the non-disclosure agreement, misappropriation of trade secrets, and
interference with prospective business relationships.
Later in March 2008, the Company and Sierra entered into a letter of intent for an
asset purchase. Sierra dismissed its claims without prejudice the same day. But
negotiations broke down, and the deal did not close.
D. The Underlying Action
On December 31, 2008, the Company filed suit against Sierra in the California
Court for breaching the letter of intent. Sierra filed counterclaims, including the claims it
previously had dismissed without prejudice, plus a new claim that the Company had
breached the letter of intent. This decision refers to the proceedings in the California
Court as the “Underlying Action.”
In February 2009, Sierra filed an amended pleading that sought to add Parent,
Grandparent, and Great-Grandparent to the litigation. Sierra did not serve Parent or
Great-Grandparent. The Company and Grandparent filed answers. Parent and Great-
Grandparent did not appear.
E. The Intervening Stock Sale And Fund Transfers
In 2012, while the Underlying Action was pending, Patriot Funding LLC (the
“Buyer”) purchased 100% of the Company‟s stock from Parent (the “Stock Sale”). The
transaction was governed by a stock purchase agreement dated May 4, 2012 (the “Stock
3
Purchase Agreement” or “SPA”). The Stock Sale closed on June 18, 2012. Effective upon
closing, Marino resigned from all of his positions with the Company.
Buyer paid Parent $230 million for the stock of the Company. Not surprisingly,
the parties to the Stock Sale bargained over the Underlying Action and allocated the risk
of an adverse outcome in the Stock Purchase Agreement. The Stock Purchase Agreement
created a special indemnification procedure for claims related to the Underlying Action,
secured by an escrow fund of $20 million. See SPA § 7.4(b); SPA Ex. D. The governing
agreements called for up to $16 million to be released from the escrow fund to Parent one
year after closing. See SPA Ex. D § 4(c). If the Underlying Action was not yet resolved at
that point, the remaining $4 million would remain in escrow until its conclusion.
Over the course of three distributions, Parent transferred $112.6 million of net sale
proceeds to the investors in Grandparent (collectively, the “Fund Transfers”). The first
transfer occurred on the date the Stock Sale closed. The second happened on February 6,
2013. The third happened on August 1, 2013. According to Sierra, Marino and the
Marino Dynasty Trust received approximately $48 million.
In the ordinary course, each distribution would have been made from Parent to
Grandparent, then Grandparent would have distributed the funds to its investors. Sierra
alleges Parent used different mechanisms to transfer funds to Marino, the Marino
Dynasty Trust, and other investors in Grandparent because Grandparent was a defendant
in the Underlying Action and Marino did not want the funds flowing through its
accounts.
4
F. The Pre-Judgment Hearing
In March 2013, Sierra moved for leave to serve Parent and Great-Grandparent
with its claims and bring them into the case as parties. Sierra argued that it needed Parent
and Great-Grandparent in the case to protect its ability to collect on a potential judgment.
In June 2013, the Company represented to the California Court that it would not
take any steps to render itself judgment-proof. Relying on the Company‟s
representations, the California Court denied Sierra‟s motion. The California Court
observed that, if necessary, Sierra could “move post trial to substitute appropriate parties
to effect judgment.” Dkt. 28, Ex. at 9.
G. The California Judgment And The Post-Judgment Motion
The Underlying Action proceeded to trial. On March 28, 2014, a jury awarded
compensatory damages of $22.3 million in favor of Sierra and against the Company and
Grandparent. On May 1, the jury awarded punitive damages of $16.2 million in favor of
Sierra and against the Company, plus $1.2 million in favor of Sierra and against
Grandparent. On October 23, the California Court awarded additional exemplary
damages of $13.1 million in favor of Sierra and against the Company. The California
Court did not award additional exemplary damages against Grandparent because it had
“no ability to pay.” Id. at 11. This decision refers to these awards collectively as the
“California Judgment.”
On July 6, 2015, Sierra moved to amend the California Judgment to add Marino,
Parent, and Great-Grandparent as judgment debtors. On January 14, 2016, Sierra filed its
amended motion (the “Post-Judgment Motion”). Sierra contended that the Post-Judgment
5
Motion was necessary because the Company and Grandparent had rendered themselves
judgment proof. According to Sierra, during the bulk of the Underlying Action, the
Company and Grandparent had a combined net worth that ranged from $118 million to
$171 million. By the time of trial however, the Company and Grandparent had reduced
their combined net worth to only $1.3 million.
To add Marino, Parent, and Great-Grandparent as judgment debtors, Sierra relied
on Section 187 of the California Code of Civil Procedure:
When jurisdiction is, by the Constitution or this Code, or by any other
statute, conferred on a Court or judicial officer, all the means necessary to
carry it into effect are also given; and in the exercise of this jurisdiction, if
the course of proceeding be not specifically pointed out by this Code or the
statute, any suitable process or mode of proceeding may be adopted which
may appear most conformable to the spirit of this code.
Cal. Civ. Proc. Code § 187. California decisions have interpreted Section 187 to confer
on a trial court the general equitable power to amend a judgment to add additional
debtors who were alter egos of parties already liable under the judgment and who
controlled the litigation that resulted in the judgment.1
1
See, e.g., McClellan v. Northridge Park Townhome Owners Ass’n, Inc., 107 Cal.
Rptr. 2d 702, 706 (Cal. Ct. App. 2001) (“[A Section 187 motion] is an appropriate and
complete method by which to bind new individual defendants where it can be
demonstrated that in their capacity as alter ego of the corporation they in fact had control
of the previous litigation, and thus were virtually represented in the lawsuit.” (quotation
marks omitted)); NEC Elecs. Inc. v. Hurt, 256 Cal. Rptr. 441, 444 (Cal. Ct. App. 1989)
(“[I]f the claim of individual liability is made at some later stage in the action, the
judgment can be made individually binding on a person associated with the corporation
only if the individual to be charged, personally or through a representative, had control of
the litigation and occasion to conduct it with a diligence corresponding to the risk of
personal liability that was involved.” (quotation marks omitted)); accord Katzir’s Floor
& Home Design, Inc. v. M-MLS.com, 394 F.3d 1143, 1148 (9th Cir. 2004) (“A § 187
6
The California Court has not yet ruled on the Post-Judgment Motion. Consistent
with cases applying Section 187, Sierra argues in the Post-Judgment Motion that Marino
should be added as a judgment debtor because (i) he was involved in the conduct that
gave rise to the California Judgment, (ii) he controlled the Company before the Stock
Sale, (iii) he deprived the Company of assets that it could use to pay the California
Judgment, and (iv) he directed the Company‟s defense in the Underlying Action.
H. This Litigation
By letter dated July 30, 2015, Marino‟s counsel asked the Company to advance the
fees and expenses that Marino would incur to oppose the Post-Judgment Motion.
Marino‟s counsel regarded the Post-Judgment Motion as a continuation of Sierra‟s claims
in the Underlying Action, which meant that the Post-Judgment Motion related to actions
that Marino had taken while an officer and director of the Company.
The Company saw things differently. By letter dated August 7, 2015, the
Company took the position that the Post-Judgment Motion focused primarily on the Fund
amendment requires (1) that the new party be the alter ego of the old party and (2) that
the new party had controlled the litigation, thereby having had the opportunity to litigate,
in order to satisfy due process concerns.” (quotation marks omitted)); In re Levander, 180
F.3d 1114, 1121 (9th Cir. 1999) (“To amend a judgment under § 187, two requirements
must usually be met: (1) that the new party be the alter ego of the old party and (2) that
the new party had controlled the litigation, thereby having had the opportunity to litigate,
in order to satisfy due process concerns.” (quotation marks omitted)); see Mesler v.
Bragg Mgmt. Co., 702 P.2d 601, 612 (Cal. 1985) (en banc) (“Plaintiffs often move
postjudgment to amend a judgment in their favor to add a previously unnamed person or
entity as a defendant on the ground that it or he is the alter ego of an originally
denominated defendant. However, such amendment is not permitted in the absence of a
showing of due diligence on the part of the plaintiff, and of participation in the defense of
the underlying action by the claimed alter ego.” (citations omitted)).
7
Transfers, which took place when Marino was no longer an officer or director of the
Company.
By letter dated September 30, 2015, Marino‟s counsel made another demand for
advancements, and Marino provided a signed undertaking to repay any advancements he
received if he was not ultimately entitled to indemnification. The Company again denied
his request.
On October 13, 2015, Marino commenced this action. He sought advancements of
attorneys‟ fees and expenses for the claims asserted against him in the Post-Judgment
Motion. He also sought fees on fees to the extent he was successful in this action. The
Company answered, and the parties cross-moved for summary judgment.
II. LEGAL ANALYSIS
Article VIII of the Company‟s certificate of incorporation states: “This
Corporation shall indemnify and shall advance expenses on behalf of its officers and
directors to the fullest extent permitted by law in existence either now or hereafter.”
Through this provision, the Company bound itself to “advance expenses on behalf of”
Marino in his capacity as one “of its officers and directors.” Once the Stock Sale closed,
however, Marino resigned from his positions with the Company and ceased to be an
officer or director.
No one disputes that if Marino had been sued by reason of his status as an officer
or director while he was serving as an officer or director, then the Company would have
been obligated to provide advancements. The dispute is about whether Article VIII
continues to cover Marino for the same types of claims now that he has ceased to be an
8
officer or director. Marino contends that he remains covered for claims challenging the
propriety of actions he took while serving an officer and a director. The Company
contends that his coverage terminated when he ceased to be an officer or a director.
Because the Company‟s charter contemplates advancement “to the fullest extent
permitted by law,” the answer turns on the language of the indemnification and
advancement statute. 8 Del. C. § 145. Three subsections of Section 145 carry particular
significance: (i) Section 145(e), which authorizes advancements, (ii) Section 145(j),
which addresses the extent to which a covered person‟s indemnification and advancement
rights for actions taken during the person‟s period of service continue after the person has
ceased to serve, and (iii) Section 145(f), which limits a corporation‟s ability to cause a
covered person‟s rights to terminate after the person has served in reliance upon them.
A. Section 145(e)
Section 145(e) of the Delaware General Corporation Law (the “DGCL”) confers
permissive authority on Delaware corporations to grant advancements.2 It states:
Expenses (including attorneys‟ fees) incurred by an officer or director of
the corporation in defending any civil, criminal, administrative or
investigative action, suit or proceeding may be paid by the corporation in
2
Homestore, Inc. v. Tafeen, 888 A.2d 204, 212 (Del. 2005) (“The advancement
authority conferred by section 145(e) is permissive.”); Citadel Hldg. Corp. v. Roven, 603
A.2d 818, 823 (Del. 1992) (same); Sodano v. Am. Stock Exch. LLC, 2008 WL 2738583,
at *15 n.83 (Del. Ch. July 15, 2008) (Strine, V.C.) (“Section 145(e) allows a corporation
to advance the costs of litigation to corporate officials. That allowance is permissive, not
mandatory and therefore a corporation is free to limit the terms of advancement and even
preclude advancement entirely.” (quotation marks and citation omitted)), aff’d sub nom.
Am. Stock Exch. LLC v. Fin. Indus. Regulatory Auth., Inc., 970 A.2d 256 (Del. 2009)
(TABLE).
9
advance of the final disposition of such action, suit or proceeding upon
receipt of an undertaking by or on behalf of such director or officer to repay
such amount if it shall ultimately be determined that such person is not
entitled to be indemnified by the corporation as authorized in this section.
Such expenses (including attorneys‟ fees) incurred by former directors and
officers or other employees and agents of the corporation or by persons
serving at the request of the corporation as directors, officers, employees or
agents of another corporation, partnership, joint venture, trust or other
enterprise may be so paid upon such terms and conditions, if any, as the
corporation deems appropriate.
8 Del. C. § 145(e).
Like other sections of Delaware law that confer specific powers on an entity,3
Section 145(e) confirms that a Delaware corporation has the authority to grant
advancements. These specific grants eliminate any doubt about whether a particular
power falls within the generalized grant of authority provided by Section 121(a) of the
DGCL, which confers on a Delaware corporation, its officers, directors, and stockholders
“all the powers and privileges granted by this chapter or by any other law or by its
certificate of incorporation, together with any powers incidental thereto, so far as such
powers and privileges are necessary or convenient to the conduct, promotion or
attainment of the business or purposes set forth in its certificate of incorporation.” 8 Del.
C. § 121(a).
3
See, e.g., id. § 122 (identifying seventeen specific grants of authority); id. § 123
(specifying a corporation‟s powers to deal in securities). See generally Carsanaro v.
Bloodhound Techs., Inc., 65 A.3d 618, 649-54 (Del. Ch. 2013) (discussing power-
conferring sections of the DGCL as a means of addressing the ultra vires doctrine as it
developed during the nineteenth and early twentieth centuries).
10
In framing the scope of the statutory authority for advancements, Section 145(e)
distinguishes between “an officer or director of the corporation” and “former directors
and officers or other employees and agents of the corporation or by persons serving at the
request of the corporation as directors, officers, employees or agents of another [entity].”
For “an officer or director of the corporation,” Section 145(e) authorizes the corporation
to provide advancements “upon receipt of an undertaking by or on behalf of such director
or officer to repay such amount if it shall ultimately be determined that such person is not
entitled to be indemnified by the corporation as authorized in this section.” For other
persons, Section 145(e) authorizes the corporation to provide advancements “upon such
terms and conditions, if any, as the corporation deems appropriate.”
The Company makes much of this distinction, which it says demonstrates that the
unqualified term “officers and directors” only means currently serving officers and
directors. Based on this reading, the Company interprets its charter provision as granting
advancement rights only to individuals who are currently serving as officers and directors
at the time of the litigation. As the Company sees it, once those individuals ceased to be
officers and directors, they became former officers and directors and no longer had
indemnification or advancement rights. Marino understands the provision differently. He
believes that he was covered while serving as an officer and director, and that he
continues to have coverage for the time during which he served as an officer and director.
His coverage may have terminated prospectively, because from that point on he was a
former officer and director, but it did not disappear retrospectively for the period of time
when he previously served.
11
Section 145 addresses this issue, but the answer is not found in Section 145(e).
Two other subsections speak to whether existing indemnification and advancement rights
continue after an individual has ceased to serve. Section 145(j) addresses the continuation
question directly and provides that the rights continue unless the governing provision
stated expressly that they would terminate. See Part II.B, infra. Section 145(f) addresses
the related issue of whether a corporation can cause a director or officer‟s coverage to
terminate, after the individual has served in reliance on it, by amending or altering the
governing provisions. See Part II.C, infra.
History teaches that Section 145(e) singles out current officers and directors in its
first sentence for a different reason. During the 1967 revision to the DGCL, which birthed
Section 145(e) substantially in its modern form,4 the drafting committee wanted to signal
that current officers and directors could receive advancements conditioned only on an
unsecured undertaking, and that a decision to grant advancements on that basis should not
be subject to challenge. At the time, prominent voices argued that statutory grants of
specific authority should displace equitable review,5 and the same drafters introduced
4
Ernest L. Folk, III, The Delaware General Corporation Law: A Commentary and
Analysis 98 (1972) (explaining that “Section 145 is a completely redrafted and greatly
expanded provision . . . and bears almost no resemblance to the prior provision”). During
the three years preceding the wholesale revisions to the DGCL in 1967, “no subject was
more discussed among members of the corporate bar than the subject of indemnification
of officers and directors.” S. Samuel Arsht & Walter K. Stapleton, Delaware’s New
General Corporation Law: Substantive Changes, 23 Bus. Law. 75, 77-78 (1967).
5
See generally Jack B. Jacobs, The Uneasy Truce Between Law and Equity in
Modern Business Enterprise Jurisprudence, 8 Del. L. Rev. 1, 4-9 (2005) (tracing history
of period); Leo E. Strine, Jr., If Corporate Action Is Lawful, Presumably There Are
12
specific statutory standards for approving related-party transactions. See 8 Del. C. § 144.
Viewed in context, these grants of authority suggest a desire to supplant fiduciary review,
as litigators subsequently argued.6
It made particular sense for the drafters to strive for a statutory safe harbor for
advancements to current officers and directors, because a Court of Chancery decision
from 1962 had questioned how current directors could advance themselves funds “before
final disposition of [the] action.” Essential Enters. Corp. v. Dorsey Corp., 182 A.2d 647,
653 (Del. Ch. 1962) (Seitz, C.). Professor Ernest L. Folk, III, who was the reporter for the
1967 revision, explained that Section 145(e) responded in significant part to Essential
Enterprises. See Folk, supra, at 101. A grant of advancements to current officers and
directors also would fall within the literal language of Section 144, which encompassed
Circumstances in Which It Is Equitable to Take That Action: The Implicit Corollary to
the Rule of Schnell v. Chris-Craft, 60 Bus. Law. 877, 881-83 (2005) (same).
6
See Havens v. Attar, 1997 WL 55957, at *14 (Del. Ch. Jan. 30, 1997) (describing
the defendants‟ argument that “the absence of specific procedural restrictions in Section
145(e) expresses an intent of our Legislature to exempt directors from liability for
breaches of the duty of loyalty when making a decision to advance expenses,” but
rejecting that position and treating the grant of advancements as an interested transaction
to which entire fairness applied); E. Norman Veasey, Jesse A. Finkelstein & C. Stephen
Bigler, Delaware Supports Directors with a Three-Legged Stool of Limited Liability,
Indemnification, and Insurance, 42 Bus. Law. 399, 411 (1987) (describing Section 145(e)
as “a legislative statement that a transaction advancing litigation expenses is fair to the
corporation if the statute is followed”); cf. C. Stephen Bigler & Blake Rohrbacher, Form
or Substance? The Past, Present, and Future of the Doctrine of Independent Legal
Significance, 63 Bus. Law. 1, 1-15 (2007) (reviewing history of Section 144 and
arguments about its scope).
13
any “contract or transaction between a corporation and 1 or more of its directors or
officers.”7
The drafters of the 1967 revision sought to eliminate uncertainty by having the
first sentence of Section 145(e) specifically authorize a corporation to provide
advancements to then-serving directors and officers conditioned solely on an unsecured
undertaking. The sentence arguably represented a legislative determination that
advancing litigation expenses to current officers or directors on that basis was entirely
fair.8
By contrast, there was no need for similar concern about granting advancements to
former officers and directors or to other persons. Granting advancements to them was not
an interested transaction. Absent additional facts that would implicate a higher standard
7
8 Del. C. § 144(a); Lewis S. Black, Jr. & A. Gilchrist Sparks, III, Analysis of the
1983 Amendments to the Delaware Corporation Law, 2 Prentice-Hall Corp. Rep. 311,
313 (1983) (“[I]n the case of a suit against directors and/or officers, the decisions to
advance expenses is often in essence an interested transaction.”); cf. Donald E. Pease,
Outside Directors: Their Importance to the Corporation and Protection from Liability,
12 Del. J. Corp. L. 25, 78 (1987) (“A remaining issue is whether the interest of the
directors in the advance transaction invokes the provisions of section 144 . . . .”).
8
See E. Norman Veasey, Directors and Officers, in R. Franklin Balotti & Jesse A.
Finkelstein, The Delaware Law Of Corporations & Business Organizations 192-93
(1980), quoted in Pease, supra, at 78 (“Section 144(a)(3) of the General Corporation Law
removes the disqualification of interested directors if the transaction „is fair to the
corporation as of the time it is authorized, approved or ratified by the board of
directors . . . .‟ Section 145(e) is a legislative statement that a transaction advancing
litigation expenses under the circumstances is fair to the corporation if the corporation
receives an undertaking to repay.”); see Havens, 1997 WL 55957, at *14 (observing that
the defendants argued that “the absence of specific procedural restrictions in Section
145(e) expresses an intent of our Legislature to exempt directors from liability for
breaches of the duty of loyalty when making a decision to advance expenses”).
14
of review, the decision to provide advancements would be protected by the business
judgment rule. The second sentence of Section 145(e) therefore provided that a
corporation could provide advancements to those individuals on terms the corporation
“deems appropriate,” i.e., in the board‟s business judgment.
The problem that the drafters sought to solve explains the superficially
counterintuitive structure of Section 145(e). Read literally, the statute requires more
before a corporation can provide advancements to “an officer or director of the
corporation” (because the first sentence requires an undertaking) than it does for “former
directors and officers” (where the statute permits the corporation to provide
advancements on whatever terms it “deems appropriate”). The drafters took this approach
because they were trying to establish a legitimizing norm for granting advancements to
current directors and officers, so they needed to say where the floor was. Advancements
to others did not raise conflict issues, so the drafters could leave the decision entirely to
the board of directors.
As Delaware law has developed, the courts have largely harmonized the two
sections. Decisions have recognized that a corporation can require more than just an
undertaking before providing advancements to “an officer or director,”9 and a ruling by
9
See, e.g., Thompson v. The Williams Cos., Inc., 2007 WL 3326007, at *2 (Del.
Ch. July 31, 2007) (Strine, V.C.) (approving board‟s decision to require a fully-secured
undertaking as a condition to advancement); see also Blankenship v. Alpha Appalachia
Hldgs., Inc., 2015 WL 3408255, at *5 (Del. Ch. May 28, 2015) (affirming advancement
provision in merger agreement that conditioned advancement on “three enumerated
„factual representations and undertakings‟”).
15
this court rejected the proposition that a discretionary grant of advancements to currently
serving directors was not subject to fiduciary review, see Havens, 1997 WL 55957, at
*14. Decisions similarly have recognized that although the second sentence of Section
145(e) technically does not mention an undertaking, the receipt of advancements carries
with it an implicit obligation to repay them if the recipient ultimately is not entitled to
indemnification.10 Any substantive distinction between the two regimes has effectively
disappeared.
Post-1967 decisions by the Delaware Supreme Court also rendered untenable the
strong-form contention that a statutory grant of authority necessarily foreclosed fiduciary
review. Perhaps most famously, the Delaware Supreme Court explained in 1971 that
“inequitable action does not become permissible simply because it is legally possible.”
Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del. 1971). In an arguably more
significant albeit less heralded decision, the Delaware Supreme Court held in 1979 that
Section 144 only addressed the statutory validity of an interested transaction; it did not
foreclose fiduciary review.11 By the takeover wars of the 1980s, it was established
doctrine that a challenged defensive measure first had to pass statutory muster, then
10
See, e.g., In re Genelux Corp., 2015 WL 6390232, at *5 (Del. Ch. Oct. 22,
2015); Mooney v. Echo Therapeutics, Inc., 2015 WL 3413272, at *1 n.6 (Del. Ch. May
28, 2015).
11
Michaelson v. Duncan, 407 A.2d 211, 218-19 (Del. 1979). See generally Blake
Rohrbacher, John Mark Zeberkiewicz & Thomas A. Uebler, Finding Safe Harbor:
Clarifying the Limited Application of Section 144, 33 Del. J. Corp. L. 719 (2008) (tracing
history of Section 144 and equitable review of statutory compliant actions).
16
survive equitable scrutiny.12 Recent Delaware cases have cited Adolf Berle‟s pithy axiom
that corporate action is always “twice tested.”13
Despite these subsequent judicial developments, the separate sentences in Section
145(e) remain. Given the historical context surrounding Section 145(e), I do not believe
they were intended to do anything more than underscore the ability of current directors
and officers to receive advancements after providing an unsecured undertaking. To my
12
See, e.g., Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1378 (Del. 1995);
Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173, 176 (Del. 1986);
Moran v. Household Prods., 500 A.2d 1346, 1356 (Del. 1985); Unocal Corp. v. Mesa
Petroleum Co., 493 A.2d 946, 955 (Del. 1985).
13
Sample v. Morgan, 914 A.2d 647, 672 (Del. Ch. 2007) (Strine, V.C.)
(“Corporate acts thus must be „twice-tested‟—once by the law and again by equity.”);
accord Quadrant Structured Prods. Co., Ltd. v. Vertin, 2014 WL 5465535, at *3 (Del.
Ch. Oct. 28, 2014) (“Delaware law adheres to the twice-testing principle.”); Carsanaro v.
Bloodhound Techs., Inc., 65 A.3d 618, 641 (Del. Ch. 2013) (“Corporate acts are „twice-
tested,‟ once for statutory compliance and again in equity.”); see In re Pure Res., Inc.
S'holders Litig., 808 A.2d 421, 434 (Del. Ch. 2002) (Strine, V.C.) (“Nothing about [the
doctrine of independent legal significance] alters the fundamental rule that inequitable
actions in technical conformity with statutory law can be restrained by equity.”).
This does not mean that statutory structure is irrelevant to fiduciary review. “To
the contrary, the structure and statutory rubric . . . are highly influential to courts shaping
the common law of corporations.” Pure Res., 808 A.2d at 434.
There are good reasons why this is so. A statute‟s own terms might
foreclose (explicitly or implicitly) the application of traditional concepts of
fiduciary duty, thereby requiring judges to subordinate default principles of
the common law to the superior mandate of legislation. The relevant
statutory technique might also be one that does not foreclose common law
equitable review altogether, but that has certain characteristics that
influence the judiciary‟s formulation of the extent and nature of the duties
owed by the fiduciaries involved in the transaction
Id. (citations omitted). In this semi-strong version, the statute is not automatically pre-
emptive but rather serves as an input that informs the scope of fiduciary review.
17
mind, the separate sentences do not suggest anything about whether individuals who
possess indemnification and advancement rights as directors or officers lose them when
they cease to serve. Section 145(j) is the statutory section that answers that question
directly, and to which this decision now turns.
B. Section 145(j)
Section 145(j) addresses what happens when an individual who is protected by
indemnification or advancement rights while serving in a covered capacity ceases to
serve in that capacity. It states:
The indemnification and advancement of expenses provided by, or granted
pursuant to, this section shall, unless otherwise provided when authorized
or ratified, continue as to a person who has ceased to be a director, officer,
employee or agent and shall inure to the benefit of the heirs, executors and
administrators of such a person.
8 Del. C. § 145(j) (the “Continuation Clause”). Unlike Section 145(e), which is a
permissive grant of authority that a corporation can make mandatory, the Continuation
Clause is a mandatory provision that requires an explicit opt-out (“unless otherwise
provided when authorized or ratified”).
The Continuation Clause establishes a default rule that indemnification and
advancement rights “shall . . . continue as to a person who has ceased to be a director,
officer, employee or agent and shall inure to the benefit of the heirs, executors and
administrators of such a person.” Moreover, the provision contemplates not only
continuation for a living individual who has “ceased to be a director, officer, employee,
or agent,” but also continuation for the benefit of the heirs, executors, and administrators
of an individual who has, in all senses, “ceased to be.” Far from implying that the rights
18
to indemnification and advancement that protect a current director or officer cease when
the individual leaves office and becomes a former director and officer, the Continuation
Clause says exactly the opposite: Unless the right specifically stated otherwise when the
coverage was authorized or ratified, the protection continues.
Section 145(j) was not part of the 1967 revisions to the DGCL. The General
Assembly added this section in 1986 in the post-Van Gorkom statutory package that
included charter-based exculpation under Section 102(b)(7).14 “The amendments were
prompted by a growing awareness by members of the Corporation Law Section of the
Delaware Bar Association that directors‟ concerns about personal liability were causing
14
See 65 Del. Laws ch. 289 (1986) (authorizing charter-based exculpation subject
to enumerated exceptions and amendments to Section 145). The previous year, in Smith
v. Van Gorkom, 488 A.2d 858 (Del. 1985), the Delaware Supreme Court held directors
personally liable for breaching their fiduciary duties by selling their corporation for cash
in a single-bidder process that the court deemed inadequate. Many commentators
described the decision as contributing to a crisis in the directors‟ and officers‟ insurance
market. See, e.g., John C. Coffee, Jr., Shareholders Versus Managers: The Strain in the
Corporate Web, 85 Mich. L. Rev. 1, 18 n.46 (1986) (“Possibly [due to Van Gorkom and
the fallout from the failure in 1984 of the Continental Illinois National Bank and Trust
Company], directors‟ and officers‟ liability insurance has become increasingly hard to
obtain, and recent newspaper reports suggest that directors have become extremely
anxious about their exposed position.”); Bayless Manning, Reflections and Practical Tips
on Life in the Boardroom After Van Gorkom, 41 Bus. Law. 1, 6 (1985) (“Premium rates
for directors‟ and officers‟ insurance have soared within the past six months, and the
availability of directors‟ and officers‟ insurance has been curtailed as insurers have
dropped out of the field and policies have been cancelled. The Van Gorkom decision will
aggravate that trend.”). Delaware responded with a package of legislation that offered
“the best practical solution, within the existing jurisprudential and legislative framework,
to what has been characterized as the „D & O Crisis‟ and its attendant problem of director
resignation.” Veasey et al., supra, at 401.
19
Delaware corporations to lose, or to be unable to attract, qualified men and women to
serve on their boards.” Black & Sparks, supra, at 311.
Before the 1986 amendments, Section 145(f) included a statement to the effect
that indemnification rights “shall . . . continue as to a person who has ceased to be a
director, officer, employee or agent.” But Section 145(f) more prominently addressed the
degree to which indemnification rights under or granted pursuant to the statue were non-
exclusive, which had been a matter of considerable interest from 1967 onward.15 The
continuation language had not received similar attention. The 1986 amendments removed
the continuation concept from the non-exclusivity provision‟s shadow and gave it a
statutory home of its own in Section 145(j).
The plain and mandatory language of Section 145(j) now states that when a person
has served in a covered capacity and made decisions or taken actions that implicate
indemnification or advancement rights, then the coverage that person received in that
capacity “shall . . . continue” unless the original grant of rights “otherwise provided.”
This means that if a person serves as a director and makes a decision, and if that person
would be entitled to receive advancements in litigation over that decision while serving
15
See Folk, supra, at 101-03 (discussing non-exclusivity clause); Veasey et al.,
supra, at 413-17 (same); see also Waltuch v. Conticommodity Servs., Inc., 88 F.3d 87, 89-
95 (2d Cir. 1996) (ruling on scope of non-exclusivity clause); Joseph W. Bishop, Jr.,
Sitting Ducks and Decoy Ducks: New Trends in the Indemnification of Corporate
Directors and Officers, 77 Yale L.J. 1078, 1085 (1968) (reviewing legislative history of
non-exclusivity clause); David M. Mace, Directors and Officers Liability Insurance, 85
Banking L.J. 39, 42-44 (1968) (analyzing Delaware‟s non-exclusivity clause and
comparing it to similar provisions from other states).
20
as a director, then that person‟s rights to advancements “shall . . . continue” after that
person “has ceased to be a director.” Put differently, if the person is sued over the
decision after that person “has ceased to be a director,” the person is still entitled to
advancements because the rights that the person had when serving “shall continue.”
Under the Continuation Clause, the only way that a covered person loses coverage
after having “ceased to be a director” is if the source of the coverage “otherwise provided
when authorized or ratified.” For example, an advancement right would terminate upon
cessation of service if it said during the time when the director took the challenged action
that “a director shall receive mandatory advancements while serving as a director, but
will no longer receive mandatory advancements after having ceased to be a director.”
By making clear that the operative scope of coverage is what existed “when
authorized or ratified,” Section 145(f) focuses on the protection in effect during the
covered person‟s period of service, In this fashion, the Continuation Clause operates in
harmony with other subsections of Section 145 that turn on the individual‟s capacity
during the underlying events that led to the litigation, rather than the individual‟s capacity
at the time suit is ultimately filed.
Section 145(a) is illustrative. In authorizing indemnification for third party actions,
it states:
A corporation shall have power to indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, . . . by reason of the fact that the
person is or was a director, officer, employee or agent of the corporation,
or is or was serving at the request of the corporation as a director, officer,
employee or agent of another [entity] against expenses . . . actually and
reasonably incurred by the person in connection with such action, suit or
21
proceeding if the person acted in good faith and in a manner the person
reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe the person's conduct was unlawful.
8 Del. C. § 145(a) (emphasis added). In this provision, the phrase “is or was” does not
create a distinction based on the individual‟s capacity at the time of suit. Precisely the
contrary, the phrase eliminates that issue by authorizing indemnification in either case
(“is or was”) and shifting the focus to the individual‟s capacity at the time of the events
giving rise to the suit. For purposes of statutory authority, capacity at the time of suit is
irrelevant. The statute instead turns on whether the individual became involved in the
litigation “by reason of” the individual‟s service in a covered capacity. Consistent with
the Continuation Clause, Section 145(a) grants authority to a corporation to indemnify a
person who “is or was” a director for actions that they took while a director. The “was”
compliments the default rule of the Continuation Clause, which states that unless the
indemnification or advancement right specifies otherwise, coverage for actions taken
while in a covered capacity continues after the person “has ceased” to serve in the
covered capacity.
Parallel usages of “is or was” appear in Section 145(b), which authorizes
indemnification for actions by or in the right of the corporation. Id. § 145(b). To the same
effect, other parts of Section 145 prominently encompass “present or former” directors,
officers, employees, or agents.16 In each case, the point of using these terms is not to
16
See id. § 145(c) (“To the extent that a present or former director or officer of a
corporation has been successful on the merits or otherwise in defense of any action, suit
22
protect persons for actions that they take after they have ceased to serve, i.e., for things
they do after becoming “formers.” The point is rather to recognize the existence of
continuing protection for those persons to the extent they took action while they were
serving in covered capacities, i.e., before they became “formers.”
C. Section 145(f)
The third informative subsection is Section 145(f), which addresses whether a
corporation can alter or eliminate the indemnification or advancement coverage that the
corporation provided to an individual while serving in a covered capacity after that
individual has served in reliance upon it. This scenario involves a more extreme variant
of the continuation issue. Instead of addressing whether a covered person‟s rights
presumptively continue, Section 145(f) answers the more serious question of whether a
corporation can cause those rights not to continue by altering or eliminating them.
or proceeding referred to in subsections (a) and (b) of this section, or in defense of any
claim, issue or matter therein, such person shall be indemnified against expenses
(including attorneys‟ fees) actually and reasonably incurred by such person in connection
therewith.” (emphasis added)); id. § 145(d) (“Any indemnification under subsections (a)
and (b) of this section (unless ordered by a court) shall be made by the corporation only
as authorized in the specific case upon a determination that indemnification of the present
or former director, officer, employee or agent is proper in the circumstances because the
person has met the applicable standard of conduct set forth in subsections (a) and (b) of
this section.” (emphasis added)); id. § 145(h) (“For purposes of this section, references to
„the corporation‟ shall include, in addition to the resulting corporation, any constituent
corporation . . . so that any person who is or was a director, officer, employee or agent of
such constituent corporation, or is or was serving at the request of such constituent
corporation as a director, officer, employee or agent of another [entity] shall stand in the
same position under this section with respect to the resulting or surviving corporation as
such person would have with respect to such constituent corporation if its separate
existence had continued.” (emphasis added)).
23
In its present incarnation, the relevant part of Section 145(f) states:
A right to indemnification or to advancement of expenses arising under a
provision of the certificate of incorporation or a bylaw shall not be
eliminated or impaired by an amendment to the certificate of incorporation
or the bylaws after the occurrence of the act or omission that is the subject
of the civil, criminal, administrative or investigative action, suit or
proceeding for which indemnification or advancement of expenses is
sought, unless the provision in effect at the time of such act or omission
explicitly authorizes such elimination or impairment after such action or
omission has occurred.
Id. § 145(f) (the “No Termination Clause”). The General Assembly added this language
to Section 145(f) in 2009, prompted by a decision which held that a covered person‟s
advancement rights did not vest through service and did not presumptively continue to
provide coverage for actions taken during the period of service after the director became
a “former,” thereby enabling a corporation to eliminate a director‟s coverage for past
service. See Schoon v. Troy Corp., 948 A.2d 1157, 1168 (Del. Ch. 2008), superseded by
statute, 77 Del. Laws Ch. 14, § 3 (2009).
The Schoon case involved a claim for advancements by William J. Bohnen, who
had served as a director of Troy Corporation until he resigned in February 2005. During
his time as a director, the relevant provision of Troy‟s bylaws stated: “[T]he Corporation
shall pay the expenses incurred by any present or former director.” Id. at 1165. Another
section of Troy‟s bylaws tracked the Continuation Clause and provided as follows:
The rights conferred by this Article shall continue as to a person who has
ceased to be a director or officer and shall inure to the benefit of such
person and the heirs, executors, administrators and other comparable legal
representatives of such person.
Id. at 1166.
24
After Bohnen resigned, the Troy board of directors amended the bylaws to remove
the word “former.” The board accomplished this by striking the phrase “the Corporation
shall pay the expenses incurred by any present or former director” and replacing it with
the following language: “Losses reasonably incurred by a director or officer in defending
any threatened or pending Proceeding . . . shall be paid by the Corporation in advance of
the final disposition.” Id. at 1169. The Troy board of directors did not amend the
continuation provision.
Troy subsequently filed a plenary action against Bohnen in which Troy alleged
that Bohnen had breached his fiduciary duties while serving as a director. Bohnen
demanded that Troy advance his legal fees. Troy refused, arguing that Bohnen was now a
former director and that its bylaws no longer provided advancements to former directors.
In the ensuing litigation over Bohnen‟s advancement rights, the trial court held
that Bohnen did not have a right to advancements. The decision interpreted the amended
bylaw as limiting advancements to directors and officers who were serving in office at
the time suit was filed. Because the amendment eliminated a right Bohnen previously had
enjoyed, the court considered whether Bohnen‟s rights had vested at the time of the
amendment. The court held that a director‟s advancement rights did not vest until suit
was filed, and thus a board could change a director‟s rights at any time before that point.
The court read the continuation provision of the bylaws and the Continuation Clause in
Section 145 as only contemplating continuation of advancement and indemnification
rights after a lawsuit was filed. Under this reading, Bohnen‟s right to advancement right
25
had not yet vested at the time of the amendment, so the board could eliminate it without
Bohnen‟s consent.
The Schoon case settled before the Delaware Supreme Court could hear the
appeal, but the trial court decision was “promptly overturned by the Delaware General
Assembly.” Andrew M. Johnston, Amy L. Simmerman & Jeffrey M. Gorris, Recent
Delaware Law Developments in Advancement and Indemnification: An Analytical Guide,
6 N.Y.U. J. L. & Bus. 81, 113 (2009). The synopsis to the amendment stated that the No
Termination Clause “adopt[ed] a default rule different than the approach articulated in
[Schoon].” Del. H.B. 19, 145th Gen. Assem. syn. § 3 (2009).
In that vein, the No Termination Clause started from a different premise than the
Schoon decision. The decision posited that a covered person‟s rights did not vest until the
filing of litigation and hence could be altered or eliminated at any point before then. The
No Termination Clause chose a different point in time for vesting by providing that
indemnification and advancement rights “shall not be eliminated or impaired by an
amendment to the certificate of incorporation or the bylaws after the occurrence of the act
or omission that is the subject of the civil, criminal, administrative or investigative action,
suit or proceeding for which indemnification or advancement of expenses is sought.” The
statutory language recognizes that a covered person serves in a covered capacity in
reliance on the indemnification and advancement rights that the corporation has provided,
establishing a contractual relationship. As a matter of black letter contract law, the
covered person‟s service provides the consideration necessary to form a binding contract.
See Restatement (Second) of Contracts § 53 (1981). Because the individual‟s rights vest
26
at that point, they cannot be amended retroactively unless the original grant of protection
specifically contemplated the possibility of after-the-fact amendment.
The No Termination Clause also started from a different premise than the Schoon
decision on another key issue. The Schoon decision analyzed advancement and
indemnification rights based on the individual‟s capacity at the time of suit, which
enabled the court to conclude that the rights had been terminated. By specifying that the
rights are fixed at “the act or omission that is the subject of the civil, criminal,
administrative or investigative action,” the No Termination Clause confirms that
coverage turns on the individual‟s capacity at the time of service, consistent with other
subsections in Section 145. See Part II.B, supra.
To illustrate the changes worked by Section 145(j), an analogy to insurance law
may be helpful. Under the rejected Schoon approach, indemnification and advancement
rights would have operated in a manner analogous to claims-made coverage. Under the
post-amendment approach, indemnification and advancement rights operate like
occurrence-based insurance coverage.17 Under the occurrence-based system, protection
17
See 43 Am. Jur. 2d Insurance § 681 (“The basic distinction between „claims
made‟ and „occurrence policies‟ is that while the occurrence policy is triggered by the
insured‟s liability-producing conduct, the claims made policy is triggered by the
presentation of a claim.”). Compare 45 C.J.S. Insurance § 640 (“An occurrence type of
liability policy protects the policyholder from damages resulting from acts occurring
during the period in which the policy is in effect. The nature of an occurrence policy is to
provide coverage for all occurrences that take place during the policy period, regardless
of when the claim is presented.” (footnotes omitted)), with id. § 642 (“A „discovery‟ or
„claims made‟ policy is one in which indemnity is provided no matter when the alleged
error or omission or act of negligence occurred, provided the misdeed complained of is
27
for the covered period persists, even though time has marched on and the individual has
ceased to serve by the time the lawsuit is eventually filed. Consequently, “[a] director
who has retired or resigned normally has continuing protection.” 1 R. Franklin Balotti &
Jesse A. Finkelstein, The Delaware Law of Corporations and Business Organizations §
4.12[F], at 4-89 (Supp. 2013).
D. Delaware Public Policy
Section 145(e), the Continuation Clause, and the No Termination Clause thus
establish a framework in which (i) a corporation can grant mandatory advancement rights
to directors and officers that provide coverage conditioned solely on an undertaking
(Section 145(e)), (ii) those rights presumptively continue to provide coverage for actions
the individuals took during their period of service even after the individuals have ceased
to serve (Section 145(j)), and (iii) those rights presumptively cannot be altered or
eliminated after they have exposed themselves to potential suit by serving on the
corporation‟s behalf (Section 145(f)). This structure implements the public policy
foundation for advancement and indemnification rights, which is to “encourage capable
men [and women] to serve as corporate directors, secure in the knowledge that expenses
incurred by them in upholding their honesty and integrity as directors will be borne by
the corporation they serve.”18
discovered and the claim for indemnity is made against the insurance company during the
policy period.”).
18
Stifel Fin. Corp. v. Cochran, 809 A.2d 555, 561 (Del. 2002) (quotation marks
omitted); accord Homestore, Inc. v. Tafeen, 888 A.2d 204, 211 (Del. 2005)
28
The public policy foundation for advancement and indemnification rights has
particular salience when lawsuits target former directors and officers for actions taken
during their periods of service. As Chief Justice Strine explained while serving as a Vice
Chancellor,
Corporate advancement practice has an admittedly maddening aspect. At
the time that an advancement dispute ripens, it is often the case that the
corporate board has drawn harsh conclusions about the integrity and fidelity
of the corporate official seeking advancement. The board may well have a
firm basis to believe that the official intentionally injured the corporation. It
therefore is reluctant to advance funds for his defense, fearing that the funds
will never be paid back and resisting the idea of seeing further depletion of
corporate resources at the instance of someone perceived to be a faithless
fiduciary.
But, to give effect to this natural human reaction as public policy would be
unwise. Imagine what EDS believes to be unthinkable: that the United
States government and EDS are in fact wrong about Reddy. What if he in
fact did not falsify records? What if he in fact did not do anything that was
even grossly negligent? In that circumstance, it would be difficult to
conceive of an argument that would properly leave him holding the bag for
all of his legal fees and expenses resulting from two cases centering on his
conduct as an employee of EDS. That result would make the promise made
to Reddy in the EDS bylaws an illusory one.
(“Advancement is an especially important corollary to indemnification as an inducement
for attracting capable individuals into corporate service.”); VonFeldt v. Stifel Fin. Corp.,
714 A.2d 79, 84 (Del. 1998) (explaining that advancement rights “encourag[e] capable
women and men to serve as corporate directors and officers, secure in the knowledge that
the corporation will absorb the costs of defending their honesty and integrity”); Folk,
supra, at 98 (“The invariant policy of Delaware legislation on indemnification is to
promote the desirable end that corporate officials will resist what they consider
unjustified suits and claims, secure in the knowledge that their reasonable expenses will
be borne by the corporation that they have served if they are vindicated.” (quotation
marks omitted)).
29
Reddy v. Elec. Data Sys. Corp., 2002 WL 1358761, at *5-6 (Del. Ch. June 18, 2002)
(footnote omitted).
As human beings, the directors serving when a lawsuit is filed have a natural
inclination to deny advancement to former directors and officers if they perceive those
individuals as having harmed the corporation. Mandatory indemnification and
advancement rights address this concern, but if those rights presumptively ceased when
an individual stopped serving as a director or officer (contra the Continuation Clause),
then former directors and officers again would face significant risk. If a corporation could
alter or terminate a director or officer‟s indemnification or advancement rights after
service but before litigation was filed (contra the No Termination Clause), then the
exposure would be greater. By establishing a statutory presumption of continuing
coverage for actions taken during the period of service, the Continuation Clause and the
No Termination Clause ensure that the public policy interest prevails, unless the
individuals know when they choose to serve that their rights will terminate or can be cut
off later.
E. The Upshot For Marino
Under the statutory framework as I understand it, the Company‟s charter conferred
indemnification and advancement rights on Marino that work as follows. When Marino
agreed to serve in a covered capacity, he became entitled to receive mandatory
indemnification and advancements to the fullest extent of Delaware law. That coverage
was part of the consideration that the Company offered in exchange for his service.
30
Through service, his coverage vested.19 The Company‟s charter provision did not state up
front that it could be amended retroactively or that Marino would lose coverage when he
19
See Jennings v. San Vicente Gp, Inc., C.A. No. 19348, at 10 (Del. Ch. Mar. 27,
2002) (TRANSCRIPT) (“[T]he right to seek advancement . . . came into existence . . .
when the plaintiffs became directors . . . . At that point, the right was inchoate but, by its
very nature, became exercisable when an indemnifiable event occurred.”); Salaman v.
Nat’l Media Corp., 1992 WL 808095, at *6 (Del. Super. Oct. 8, 1992) (explaining that a
director‟s rights to advancement and indemnification under the bylaws “vested” through
the director‟s service at the time of the events giving rise to the underlying lawsuit and
that the underlying lawsuit “triggered” the corporation‟s obligations under the bylaws).
Commentators who have discussed the operation of indemnification and
advancement rights after the General Assembly‟s response to Schoon have described the
point of vesting as combining both service and an event that later leads to litigation. See 1
David A. Drexler et al., Delaware Corporation Law and Practice § 16.04, at 16-23
(Supp. 2012) (“[U]nder the current default rule, the right to advancement vests at the
time of the act or omission giving rise to such right.”); Mark A. Sargent & Dennis R.
Honabach, D&O Liability Handbook § DE:2 (2015) (“[The amendment to Section
145(f)] effectively provides that a director or officers [sic] right to indemnification or
advancement under a corporate bylaw vests at the occurrence of the act or omission that
is the subject of the . . . action, suit or proceeding unless the bylaw expressly provides
otherwise. . . . Most commentators believe the court erred in Schoon and predict that
should another bylaw amendment case arise, the courts would effectively apply the new
provision retroactively.”); 1 Welch et al., Folk on the Delaware General Corporation
Law § 145.08, at 4-421-22 n.116 (6th ed. 2015) (“The 2009 amendment effectively
overruled the default position of some earlier cases holding that a director‟s right to
advancement does not vest when the director takes office, and that rights could be
eliminated where there was no evidence that the corporation was contemplating claims
against the director at the time of the amendment.”).
Because indemnification and advancement rights are triggered by actions, suits,
and proceedings, there necessarily will be an event that gives rise later to litigation.
Whether a particular act or omission will give rise to litigation often cannot not be known
at the time of the act. It seems more straightforward to me, therefore, to speak of vesting
through service. The statutory reference to the act or omission is nevertheless helpful in
emphasizing that the scope of the operative right is determined at that point. It also makes
clear that rights can be changed for prospective periods of service, but not for past
periods of service, unless the right that previously governed that past period of service
“otherwise provided when authorized or ratified.”
31
ceased to serve.20 The Company therefore could not amend the coverage retroactively
(Section 145(f)), and the coverage continues to protect Marino even though he has ceased
to serve (Section 145(j)).
Marino‟s continuing coverage is retrospective, not prospective. The coverage only
covers Marino for his period of service as an officer and director and protects him against
lawsuits brought “by reason of” his service.21 Marino is not covered for actions taken
20
See Jennings, C.A. No. 19348, at 11 (“The right that had vested in these
plaintiffs was a contract right that, as in the Salaman case, cannot be taken away once it
became vested.”); Salaman, 1992 WL 808095, at *6 (explaining that a director‟s “right to
advancement and indemnification is a vested contract right which cannot be unilaterally
terminated”); see also In re Genelux Corp., 2015 WL 6390232, at *4 (Del. Ch. Oct. 22,
2015) (“[I]t would be inequitable to deny [a former director] his claimed right to
advancement . . . . To hold otherwise would allow the Company to allege misconduct of a
director in his capacity as a fiduciary and to attempt to invalidate his personal property
rights and related corporate rights without naming him a defendant, thereby forcing him
either to intervene in the action at his own expense or risk losing important rights.”);
Kidsco Inc. v. Dinsmore, 674 A.2d 483, 492 n.6 (Del. Ch. 1995) (stating that “no
„contractual‟ right to maintain an existing by-law has ever been recognized, except in the
compelling (and quite different) context of a director‟s individual indemnification rights
that became perfected before the board amended its by-laws”), aff’d, 670 A.2d 1338 (Del.
1995); see also Bergonzi v. Rite Aid Corp., 2003 WL 22407303, at *3 (Del. Ch. Oct. 20,
2003) (holding that corporation could not “unilaterally rescind” its charter provision that
barred the corporation from asserting a “conduct” defense in advancement action and
explaining that the corporation “must now maintain its bargain with its former officer”).
21
See Homestore, Inc. v. Tafeen, 888 A.2d 204, 213-14 (Del. 2005) (granting
advancements to former officer where officer was named as a defendant in lawsuits “by
reason of” actions he allegedly took during his period of service); Stockman v. Heartland
Indus. P’rs, L.P., 2009 WL 2096213, at *5-9 (Del. Ch. July 14, 2009) (Strine, V.C.)
(granting advancement to two former officers and directors of a limited partnership for
civil and criminal proceedings brought against them in connection with their roles at the
company); Paolino v. Mace Sec. Int’l, Inc., 985 A.2d 392, 403 (Del. Ch. 2009) (granting
advancement to former chairman and CEO of corporation to assert counterclaims in
lawsuits “by reason of the fact” of his service); Bernstein v. TractManager, Inc., 953
A.2d 1003, 1011 (Del. Ch. 2007) (granting advancements to former officer where officer
32
after he stopped serving, once he became a former officer and director. Charney v. Am.
Apparel, 2015 WL 5313769, at *6-7 (Del. Ch. Sept. 11, 2015).
Although the coverage that the Company provided to Marino vested as a result of
his service, the coverage did not ripen into an enforceable right until triggered by a
covered claim. The point at which a covered claim triggers an enforceable right is
different for advancement and indemnification.
Marino‟s mandatory advancement right ripened upon the existence of the covered
claim. For these purposes, a covered claim is not limited to actual litigation. 22 It extends
to “any civil, criminal, administrative, or investigative action, suit or proceeding” for
which the covered person might receive indemnification. 8 Del. C. § 145(e). Importantly,
because the advancement right extends “to the fullest extent permitted by law,” it
was named as a defendant in lawsuits “by reason of” actions he allegedly took during his
period of service); Brown v. LiveOps, Inc., 903 A.2d 324, 329 (Del. Ch. 2006) (granting
advancements to former officer and director “by reason of the fact” of his previous
service); Weinstock v. Lazard Debt Recovery GP, LLC, 2003 WL 21843254 (Del. Ch.
Aug. 8, 2003) (Strine, V.C.) (holding that a corporation‟s advancement provision “does
not grant advancement rights solely to Indemnified Parties who are currently serving in
an official capacity, but instead to all Indemnified Parties facing proceedings as defined
in” the relevant provision); Reddy v. Elec. Data Sys. Corp., 2002 WL 1358761, at *1-3
(Del. Ch. June 18, 2002) (Strine, V.C.) (granting advancement to former employee to
defend lawsuit brought “by reason of” his service as an employee); cf. Gentile v.
SinglePoint Fin., Inc., 788 A.2d 111, 113 (Del. 2001) (per curiam) (denying advancement
where bylaw expressly limited mandatory right of advancement to “named defendants”).
22
See 8 Del. C. § 145(e); Brady v. i2 Techs. Inc., 2005 WL 3691286, at *1-2, *4
(Del. Ch. Dec. 14, 2005) (granting advancement to former executive and director for
expenses relating to an internal investigation); Tafeen v. Homestore, Inc., 2005 WL
789065, at *1-2 (Del. Ch. Mar. 29, 2005) (granting advancement to former officer
relating to an internal investigation), aff’d, 888 A.2d 204 (Del. 2005).
33
encompasses not only any proceeding for which Marino might later be indemnified under
Section 145(a) or (b), but also any proceeding for which he might later be indemnified
under Section 145(c).23
More than the existence of a covered claim is necessary to cause Marino‟s
mandatory indemnification right to ripen. An indemnification right ripens upon (i) the
final disposition of the covered claim or (ii) in the case of statutory indemnification under
Section 145(c), success on the merits or otherwise. See Sun-Times Media Gp., Inc. v.
Black, 954 A.2d 380, 397 (Del. Ch. 2008) (Strine, V.C.). “It is generally premature to
consider indemnification prior to the final disposition of the underlying action.” Paolino
v. Mace Sec. Int’l, Inc., 985 A.2d 392, 397 (Del. Ch. 2009).
1. Application To The Post-Judgment Motion
Determining whether and to what degree Marino is entitled to advancements
requires applying the preceding framework to the Underlying Action. Marino only seeks
advancements for defending against the Post-Judgment Motion. He has not sought
advancements for any expenses incurred defending against earlier phases of the
23
See Dunlap v. Sunbeam Corp., 1999 WL 1261339, at *5 (Del. Ch. July 9, 1999)
(holding that advancements were required under mandatory provision so long as
mandatory indemnification under Section 145(c) remained a possibility); see also Zaman
v. Amedeo Hldgs., Inc., 2008 WL 2168397, at *16 (Del. Ch. May 23, 2008) (Strine, V.C.)
(interpreting a bylaw provision that granted indemnification to an agent “to the full extent
permitted by Delaware law” as encompassing mandatory indemnification as permitted by
Section 145(c)); Cochran v. Stifel Fin. Corp., 2000 WL 1847676, at *8 (Del. Ch. Dec. 13,
2000) (Strine, V.C.) (interpreting bylaw provision that mandated indemnification of a
party serving as a director, officer, and employee of a subsidiary “to the fullest extent
permitted by Delaware law” as encompassing mandatory indemnification as permitted by
Section 145(c)), aff’d in pertinent part, 809 A.2d 555 (Del. 2002).
34
Underlying Action. The scope of an individual‟s advancement rights normally turns on
the pleadings in the underlying litigation that trigger the advancement right.24 In this case,
the scope of Marino‟s right to advancement turns on the assertions in the Post-Judgment
Motion.
The analysis of the Post-Judgment Motion in turn requires distinguishing between
(i) portions of the Post-Judgment Motion in which Marino is being pursued by reason of
his service as a director and officer of the Company and actions he took in those
capacities and (ii) portions of the Post-Judgment Motion relating to Marino‟s actions after
he resigned. Marino is entitled to advancement for the former. He is not entitled to
advancement for the latter. See Charney, 2015 WL 5313769, at *6-7.
Recall that the Post-Judgment Motion relies on Section 187 of the California
Code, which states:
When jurisdiction is, by the Constitution or this Code, or by any other
statute, conferred on a Court or judicial officer, all the means necessary to
carry it into effect are also given; and in the exercise of this jurisdiction, if
the course of proceeding be not specifically pointed out by this Code or the
24
Holley v. Nipro Diagnostics, Inc., 2014 WL 7336411, at *8 (Del. Ch. Dec. 23,
2014) (“[I]n this case, the „by reason of the fact‟ analysis requires looking to the
allegations in the SEC‟s complaint. In that regard, I note that courts can often determine
whether the „by the reason of the fact‟ requirement that has been satisfied solely by
examining the pleadings in the underlying litigation . . . .” (footnote omitted)); Pontone v.
Milso Indus. Corp., 100 A.3d 1023, 1051 (Del. Ch. 2014) (“Having re-examined the
amended complaint in the Pennsylvania Action, I find that . . . Scott was made a party to
the Pennsylvania Action “by reason of” his former corporate office.”); see also Tafeen,
888 A.2d at 207 (examining allegations in underlying proceedings); Brown, 903 A.2d at
328-29 (looking at complaint from underlying litigation in conducting “by reason of the
fact” analysis); Reddy, 2002 WL 1358761, at *2 (examining criminal and civil complaint
in conducting “by reason of” analysis).
35
statute, any suitable process or mode of proceeding may be adopted which
may appear most conformable to the spirit of this code.
Cal. Civ. Proc. Code § 187. To add a post-judgment debtor under Section 187, the
movant must show “(1) that the new party be the alter ego of the old party and (2) that the
new party had controlled the litigation, thereby having had the opportunity to litigate, in
order to satisfy due process concerns.” Katzir’s Floor & Home Design, Inc. v. M-
MLS.com, 394 F.3d 1143, 1148 (9th Cir. 2004) (quotation marks omitted); accord Mesler
v. Bragg Mgmt. Co., 702 P.2d 601, 612 (Cal. 1985) (en banc) (requiring the movant to
show (i) the new party was the alter ego of the old party, (ii) “due diligence on the part of
the plaintiff,” and (iii) the new party participated in the underlying defense).
The Post-Judgment Motion focuses in large part on action that Marino took in a
covered capacity while serving as a director and officer of the Company, but it also
involves some conduct that took place after Marino resigned from his positions with the
Company. In the Post-Judgment Motion, Sierra states that “Marino personally
participated in the conduct underlying the judgment.” Dkt. 28, Ex. at 25. Sierra supports
this assertion with the following:
[T]he Court already held [Marino] was personally involved in the conduct
underlying the judgment. In its Order Denying [the Company‟s] Rule 50(b)
and 59 Motions, the Court held that Marino‟s personal conduct was
“sufficient to show repeated trickery and deceit” on the part of [Parent] and
[the Company]. The Court concluded that Marino . . . told Sierra that [the
Company] would take no action at McClellan without Sierra, and that [the
Company‟s] illicit bid was merely a “second bite at the apple” for Sierra.
The Court also concluded that Marino himself “convinced Sierra to lower
its capital investment offer” to McClellan, after which [the Company]
submitted a bid doubling Sierra‟s offer. Sierra relied on Marino‟s
misrepresentations to its detriment and incurred severe damages.
36
Id. at 26 (citations and formatting omitted). These assertions depend on Marino
exercising corporate authority as an officer of the Company and involve covered conduct.
Cf. Charney, 2015 WL 5313769, at *6-7.
Sierra also contends in the Post-Judgment Motion that Marino received
confidential information from Sierra in his capacity as the Company‟s CEO, then caused
the Company to use Sierra‟s confidential information to bid in response to and win
McClellan‟s request for proposal. This is covered conduct. See LiveOps, 903 A.2d at 326(finding causal connection requirement satisfied where former officer allegedly
misappropriated the corporation‟s trade secrets while a director).
The Post-Judgment Motion similarly implicates covered conduct by arguing that
Parent and Great-Grandparent were alter egos of the Company before the Stock Sale,
during Marino‟s time as the Company‟s Chairman and CEO. See Dkt. 28, Ex. at 1. In
support of that argument, Sierra claims that:
 “Marino dominated and controlled” the Company before the Stock Sale.
 The “pre-sale” Company was an “arm[] and instrumentalit[y] of Marino.”
 Marino “managed” the Company as the “operational arm” of his family of entities,
“in pursuit of common business purpose.”
 Marino was in charge of the Company‟s daily operations.
 Marino had final approval on everything that took place within the Company.
Id. at 19-22. Without expressing a view on whether allegations of this type would be
sufficient to establish alter ego liability, which is an issue for the California Court, these
37
contentions necessarily invoke Marino‟s corporate authority as the senior officer of the
Company.
A separate aspect of the Post-Judgment Motion, however, rests only partially on
Marino‟s conduct in a covered capacity. Sierra argues that Section 187 permits a party to
be added as a judgment debtor when the party participated in the litigation that gave rise
to the judgment. See id. at 2. Before the Stock Sale, Marino supervised and controlled the
litigation in his capacity as the senior officer at the Company. He remained in that role
for the first four years of the proceedings. After the Stock Sale, however, Marino
resigned from his positions with the Company. At that point, he may have participated in
the litigation through his control of Grandparent, but his involvement was not “by reason
of” his service to the Company. He is entitled to advancement for his pre-resignation
control over the litigation but not for his post-resignation involvement.
A final aspect of the Post-Judgment Motion does not involve covered conduct.
The Pre-Judgment Motion asserts that Marino engaged in the Fund Transfers to defraud
Sierra. Sierra further alleges that Marino caused the Company and Grandparent to
represent to the California Court that “there would be no shifting or moving of assets to
avoid judgment,” then contradicted that representation by effecting the Fund Transfers.
Id. at 23. These representations were made in June 2013, after the Stock Sale closed and
Marino resigned from all positions with the Company. Likewise, the Fund Transfers
occurred after the Stock Sale closed. The Company never received any funds. Parent sold
the Company‟s stock to Buyer, and Parent received the money. Marino did not exercise
38
Company authority in connection with any of these actions, and he is not entitled to
advancements for defending this aspect of the Post-Judgment Motion.
2. Implementation Going Forward
Marino is thus entitled to some but not all of the fees and expenses that he has and
will incur defending against the Post-Judgment Motion. To implement this ruling, the
parties shall proceed as follows:
1. Before the fifth calendar day of each month, Marino‟s counsel will submit an
advancement demand for fees and expenses incurred during the previous month.
Any fees or expenses not included in the demand are deemed waived. The
advancement demand will include the following:
a. A detailed invoice identifying the fees and expenses for which
advancement is requested. The invoice shall provide for each time entry
the date, timekeeper, billing rate, task description, time incurred, and
amount charged. The invoice shall identify with detail for each expense
the date of the charge, its nature, and the amount incurred.
b. A certification signed by the senior member of the Delaware bar
representing Marino attesting that (i) he personally reviewed the
invoice, (ii) each time entry and expense falls within the scope of
Marino‟s advancement rights, (iii) in his professional judgment, the fees
and expenses charged are reasonable in light of the factors listed at Rule
1.5(a) of the Delaware Lawyers‟ Rules of Professional Conduct, and
(iv) the services rendered were thought prudent and appropriate in his
good faith professional judgment.
2. Before the tenth calendar day of the month, the Company‟s counsel will respond
to the advancement demand in writing. The response shall identify each specific
time entry or expense to which the Company objects and explain the nature of the
objection. The senior member of the Delaware bar representing the Company shall
certify that (i) he personally reviewed the advancement demand and (ii) in his
professional judgment, the disputed fees and expenses are not reasonable or
otherwise fall outside the scope of the advancement right. The response shall cite
any legal authority on which the Company relies. Any objection not included in
the response is deemed waived.
3. The Company shall pay the undisputed amount contemporaneously with the
response. If the Company disputes more than 50% of the amount sought in any
39
advancement demand, the Company shall pay 50% of the amount sought and
Marino‟s counsel shall hold the amount exceeding the undisputed amount in its
escrow account pending resolution of the dispute regarding such portion.
4. Before the fifteenth calendar day of each month, Marino‟s counsel will reply to the
advancement response in writing and provide supporting information and
authority.
5. Before the twentieth calendar day of the month, the senior members of the
Delaware bar representing each side will meet, in person, and confer regarding any
disputed amounts. Any additional advancements that results from the meet-and-
confer session will be paid with the next month‟s payment of undisputed amounts.
6. Not more frequently than quarterly, Marino may file an application pursuant to
Court of Chancery Rule 88 seeking a ruling on the disputed amounts. Briefing
shall consist of a motion, an opposition filed within fifteen days of the motion, and
a reply filed within ten days of the opposition. Marino and the Company shall not
raise any new arguments not previously raised with the other side in the applicable
demand, response, reply, or meet-and-confer. Marino and the Company only shall
cite authorities identified in writing in the applicable demand, response, or reply.
The court will determine if a hearing is warranted.
7. If the court grants an application in whole or part, then pre-judgment interest is
due on the adjudicated amount from the date of the applicable advancement
demand.
8. If the court grants an application in whole or part, then in parallel with the next
advancement demand, Marino may demand indemnification for the fees and
expenses incurred in connection with the granted application, proportionate to the
extent of success achieved. The parties shall address the indemnification demand
in the same manner as the advancement demand. Except in connection with a
successful application, Marino shall not seek or receive advancement or
indemnification for time spent preparing invoices and advancement demands,
addressing responses, or conferring regarding advancement requests.
F. Fees On Fees
Because Marino succeeded in part on the merits of his claim for advancements, he
is entitled to an award of fees and expenses proportionate to his success. See 8 Del. C. §
145(c); Stifel Fin. Corp. v. Cochran, 809 A.2d 555, 561 (Del. 2002); Fasciana v. Elec.
Data Sys. Corp., 829 A.2d 178, 183 (Del. Ch. 2003) (Strine, V.C.). Delaware
40
corporations “remain free to tailor their indemnification bylaws to exclude „fees on
fee‟s,‟ if that is a desirable goal.” Stifel, 809 A.2d at 561-62. The charter provision in this
case does not exclude fees on fees.
Marino prevailed in his request for advancement, but not on all points. Marino is
entitled to a proportionate recovery of his fees and expenses. See Levy v. HLI Operating
Co., Inc., 924 A.2d 210, 226-27 (Del. Ch. 2007). Marino shall make an application for a
specific amount pursuant to paragraph 8 of the procedures set out in the preceding
section. See Part II.E.2, supra.
III. CONCLUSION
Marino‟s motion for summary judgment is granted. The Company‟s motion is
denied.
41