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Chancery Court: Officer Can Seek Advancement From Companies Despite Having Another Source

Friday, August 29, 2014

By Michael Greene

Aug. 22 — The Delaware Court of Chancery Aug. 22 held that once a director and officer begins pursing mandatory advancement and indemnification rights from one corporation, the officer does not lose standing to seek the same from another corporation for expenses that have not yet been paid.

Vice Chancellor Donald F. Parsons, Jr. said to hold otherwise might create a “perverse incentive” for companies to delay paying advancements in the hope they will be let off the hook from their own contractual obligations by another source paying first.

Parsons discussed numerous issues with respect to indemnification and advancement rights, in particular when a director and officer has (1) a contractual right to mandatory advancement, (2) standing for overlapping indemnification and advancement obligations, and (3) the right to advancement for counterclaims.

Dueling Motions

Petitioner Scott Pontone was an officer and director of The York Group, Inc. and Milso Industries Corp. In 2007, Pontone filed a lawsuit against York that settled later that year. As part of the settlement, Pontone agreed to resign from his positions with York and Milso, and not to compete with either company for three years. After that time period, Pontone entered into a “Consulting Agreement” to assist Batesville Casket Co., a competitor of York and Milso, in marketing its products.

In 2010, York and Milso filed a lawsuit in the U.S. District Court for the Western District of Pennsylvania alleging that Pontone misappropriated their confidential information and trade secrets. In response, Pontone filed numerous counterclaims.

In July 2013, pursuant to the bylaws of York and Milso, Pontone sought advancements from both companies for the legal fees and expenses he incurred in the Pennsylvania action.

After York categorically declined the request and Milso responded with conditions on its intent to pay, Pontone filed an advancement proceeding in August 2013 against both York and Milso. The companies moved to dismiss on the grounds that Pontone lacked standing because he is entitled and has been receiving mandatory advancements from Batesville under the consulting agreement and an April 2013 loan agreement. The agreements would provide him with funds to pay his legal fees and expenses in the Pennsylvania action, as well as in any advancement proceeding against York and Milso.

Pontone filed a motion for partial summary judgment, arguing that he is entitled to an advancement under both York and Milso's bylaws.

Entitlement to Advancement

After determining that the Batesville agreements provided Pontone the “functional equivalent” of mandatory advancement and indemnification rights, Parsons found that the fact that Pontone had incurred no out-of-pocket expenses and could potentially request funding for litigation expenses with Batesville did not undermine his right to receive at least partial advancement under York and Milso's bylaws—namely, for “any of his outstanding legal expenses incurred in the Pennsylvania Action since January 2013 for which he has not yet requested or received funding from Batesville under the Loan Agreement, and for the future costs and expenses that he will incur in that action.”

The court noted that the companies' “bylaws could have stated that York and []Milso will provide advancement only to the extent that covered individuals are unable to obtain advancement from other sources.”

Right to Switch

On the standing issue, the companies argued that Pontone could not demonstrate an injury-in-fact because he is not at risk to suffer any loss if they deny his advancement requests.

The court determined, however, that Pontone had standing to purse advancement claims for litigation expenses, although only for those that Batesville had not paid.

Vice Chancellor Parsons wrote: “The fact that a third party is willing to honor its contractual commitments to the plaintiff if called upon to do so should not serve as a basis for a defendant to escape its own, independent and commensurate, contractual obligations. In other words, an indemnitee having two essentially co-equal sources of advancement and indemnification should have the right to switch from one to the other in the middle of litigation, if he decides to do so.”

Mandatory or Permissive

The court then determined that conflicting parts of York's bylaws created ambiguity as to whether they provided for mandatory or permissive advancement.

Milso's bylaws indisputably provided for a right to a mandatory advancement, but Milso argued that Pontone was nonetheless not entitled to payment because the Pennsylvania action was not brought “by reason of” him being a director of the company—because he was not expressly accused of breaching a fiduciary duty and he was not a director at the time of the alleged misconduct.

The court, however, rejected this argument, reasoning that all of the claims against Pontone in the Pennsylvania action were “inextricably intertwined with and based on” his former role at Milso.

Additionally, the court determined that Pontone could receive advancement for his defamation counterclaim in the Pennsylvania action because it was asserted in defending the underlying action. Pontone's claim for false and misleading advertisement, however, was not sufficiently related to the underlying action, and thus could not be subject to an advancement.

Finally, the court determined that Pontone is entitled to 75 percent of the reasonable fees on fees the he has incurred in connection with the instant action.

To contact the reporter on this story: Michael Greene in Washington at mgreene@bna.com

To contact the editor on this story: Ryan Tuck at rtuck@bna.com

The opinion is available at http://www.bloomberglaw.com/public/document/Pontone_v_Milso_Indus_Corp_CA_No_8842VCP_2014_BL_233970_Del_Ch_Au

 

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