In a recent string of decisions, the Delaware Chancery Court has addressed the scope of the right of Directors and Officers to have their legal expenses paid while governmental investigations or legal proceedings against them are pending.
In Blankenship v. Alpha Appalachia Holdings, Inc., decided last spring, the former CEO and Chairman of Massey Energy Company, Don Blankenship, retired “not entirely voluntar[ily]” following a deadly explosion at one of the company’s coal mines. C.A. No. 10610-CB (Del. Ch. May 28, 2015). Shortly thereafter, the company was acquired by Alpha Natural Resources and the former CEO signed a new undertaking stating the company’s advancement of his legal expenses was contingent upon his representation that he “had no reasonable cause to believe that [his] conduct was ever unlawful.” Initially, the company paid Blankenship’s legal expenses arising out of the government’s investigation of the explosion. But the company ceased paying such expenses when Blankenship was criminally indicted, concluding that Blankenship had breached his undertaking and was no longer entitled to advancement.
When Blankenship initiated an action seeking advancement of his defense costs, the Court of Chancery observed the facts fit the “all too common scenario” where “mandatory advancement” to a former director and officer is terminated “when trial is approaching and it is needed most.” The court found that Blankenship’s advancement rights under Massey’s charter survived pursuant to the merger agreement. Relying on contract interpretation principles, the court further found the undertaking in the agreement between Massey and the company could not be construed to alter the company’s advancement obligation. Thus, the court concluded Blankenship was entitled to advancement of his defense costs.
The Blankenship decision is consistent with Holley v. Nipro Diagnostics, Inc., a Court of Chancery ruling from last year. C.A. No. 96779-VCP (Del. Ch. Dec. 23, 2014). In Holley, the court held the founder and chairman of a medical device company was entitled to advancement to pay for the cost of defending an SEC civil enforcement action for insider trading after pleading guilty to criminal counts arising out of the same conduct.
As a September 2015 Delaware Court of Chancery opinion demonstrates, however, there can be limitations to advancement rights. In Charney v. American Apparel Inc., the court held the founder and former Chairman and CEO of American Apparel clothing company, Dov Charney, was not entitled to advancement to cover the legal expenses he incurred while defending an action brought against him by the company. C.A. No. 11098-CB (Del. Ch. Sept. 11, 2015). Previously, following the Board’s suspension of Charney, the Board and Charney, in his personal capacity, entered into a standstill agreement and Charney resigned as a director of the company.
Some months later, the company sued Charney for allegedly breaching the standstill agreement for, among other things, discussing with a private equity firm a potential takeover of the company. Charney then brought an action seeking advancement to cover the costs of defending the company’s action. The Court of Chancery found that the indemnification agreement mandating advancement for events “related to the fact” that the founder is a director or officer of the company should be construed to require “a nexus or causal connection between the claims in the underlying proceeding and one’s official capacity” in order to obtain advancement. The court concluded that because none of the claims in the proceeding for breach of the standstill agreement “implicate his use or abuse of corporate power as a fiduciary” of the company, Charney was not entitled to advancement to defend against the claims. The court separately also concluded that Charney was not entitled to advancement because the company’s charter mandated advancement only for current directors and officers.
The Bottom Line: Delaware law provides strong protections for the right of directors and officers to obtain advancement of legal expenses incurred for investigations or claims causally connected to their positions, but these protections are not ironclad. Directors and officers should be aware that they may not be entitled to advancement to cover legal fees to defend actions that do not arise from their official fiduciary duties. Companies may want to review their governing documents and advancement provisions in light of these recent decisions to ensure that they clearly reflect the company’s intent regarding the reach of advancement.