Following a bench trial, the Delaware Court of Chancery recently denied a company director’s advancement of legal fees in connection with an alleged investigation into that director’s conduct. This is a double-rarity of sorts. Advancement disputes rarely go to trial, and advancement is rarely denied. As befits a post-trial ruling, unique facts resulted in a unique result.
The case is Hoffman v. First Wave Biopharma. First Wave is the surviving entity following an acquisition of one pharma company by another. Hoffman was an investor in the original target company, and was the only director appointed to First Wave’s board by the target’s founder and controlling shareholder, by the name of Glick.
Within two months of the transaction, the target’s stockholder representative – Fortis – sued First Wave, alleging a failure to pay both upfront consideration and milestone payments. That lawsuit was settled, but Fortis soon sued again, alleging a failure to make a required settlement payment. The parties were again close to a settlement agreement, at which point the wheels came off.
While the second settlement agreement was being negotiated, which would have required a $1.5 million payment, First Wave initiated – but did not yet publicly disclose – a $4 million capital raise. Glick, indicating that he was somehow aware of the capital raise, demanded a $1 million increase in the settlement payment to Fortis. First Wave acceded to the demand, and Fortis thereafter dismissed its lawsuit.
Glick’s knowledge of the confidential capital raise “shocked” certain of First Wave’s representatives, who speculated as to who might have leaked the information. Fingers eventually pointed at Hoffman, as the only board member who had a close relationship with Glick. However, no steps were taken to confirm that the leak came from Hoffman, both because an investigation would be costly and because management believed that identifying the leak would not remedy the situation.
Nonetheless, given concerns about Hoffman’s trustworthiness, the board came up with a process to exclude Hoffman from board discussions that might implicate Fortis. Hoffman pushed back, asserting that the board had no right to exclude him. Hoffman also lobbed accusations that the board was manipulating the company’s stock price. The board responded in writing with the assertions that Hoffman had breached his duty of loyalty, the company’s insider trading policy, and various securities laws. Hoffman’s counsel criticized the board’s allegations as not having been based on a “proper investigation.”
Hoffman thereafter sought indemnification and advancement for fees and expenses incurred in connection with the company’s “inquiry” into Hoffman’s alleged misconduct and the decision to exclude him from certain board meetings. The company promptly rejected the demand on the basis that it had neither threatened nor pursued any legal action and had not conducted “any formal investigation, inquiry, hearing, or the like” into Hoffman’s actions.
The Court of Chancery concurred with the company’s position. Hoffman’s advancement right is triggered only in connection with a “Proceeding,” the definition of which is extensive but for purposes of this dispute requires an “actual investigation or inquiry.” Hoffman bore the initial burden of establishing the existence of a covered Proceeding. Hoffman speculated that such an investigation or inquiry must have occurred in light of the board’s decision to exclude him from certain meetings and accuse him of misconduct. Hoffman also offered an alternative argument – although not presented until pre-trial briefing – that he had been subject to a threatened lawsuit or regulatory action, which also would be considered a covered Proceeding if substantiated.
As to an “actual” investigation, the evidence did not bear out Hoffman’s speculation. Hoffman was never interviewed, nor did he produce any documents in response to information requests. The company merely assumed that Hoffman had been the source of the capital-raise leak and it took steps to avoid a future leak – it never investigated whether its assumption was correct. Indeed, Hoffman explicitly had accused the board of jumping to conclusions without a proper inquiry, which the Court of Chancery found compelling. The Court of Chancery found that the board’s exclusion of Hoffman from meetings and accusations of misconduct were “remedial, not investigatory.”
As to a “threatened” lawsuit or regulatory action, the Court of Chancery found that Hoffman had waived the argument by failing to raise it prior to his pre-trial brief. While courts may allow unpled claims to proceed based on facts adduced during discovery, the plaintiff still must provide “adequate notice” of the claim prior to trial. Here, however, Hoffman did not provide such notice, given that discovery – like his complaint – focused on the existence of an actual investigation or inquiry, not a threatened proceeding. Hoffman also did not move to amend his pleadings. Ultimately, the Court of Chancery found that a short argument in pre-trial briefing was insufficient to provide the requisite notice.
The outcome here is likely the exception that proves the rule and does not indicate a sea change in how these disputes are most often resolved.