A Corporation’s Advancement of Legal Fees and Expenses to Its Officers and Directors

By Holly Vance and Sophia Lee Shin

This case involves a plaintiff who sought advancement for his legal fees and expenses in connection with insider trading charges. In opining on the defendant’s motion to dismiss or stay the action and the plaintiff’s motion for summary judgment, the Court considered various issues, including the four-factor analysis of McWane and the difference between advancement and indemnification.

Nipro Diagnostics, Inc. (“Nipro”), the defendant, acquired Home Diagnostics, Inc. (“HDI”) on March 15, 2010. Soon after the merger, the SEC began an investigation of George H. Holley (“Holley”), the founder and chairman of HDI and the plaintiff in this case, for suspicious trading in HDI stock around the time of the merger announcement (the “SEC Investigation”). On May 20, 2010, Holley requested that HDI advance his expenses in the SEC Investigation, and executed an undertaking (required with any advancement) promising to repay HDI for any advanced expenses if it were ultimately determined that Holley was not entitled to indemnification. From June 2010 to November 2010, Nipro advanced Holley’s expenses relating to the SEC Investigation. On January 13, 2011, the SEC commenced an action against Holley for violating federal securities laws by disclosing information about the merger (the “SEC Action”). On February 4, 2011, Holley was indicted in the U.S. District Court for the State of New Jersey for insider trading (the “Criminal Action”). On August 19, 2011, the New Jersey U.S. Attorney’s Office obtained a stay of the SEC Action. Holley eventually pled guilty to two counts of insider trading in the Criminal Action.

On November 19, 2012, Nipro commenced an action against Holley (the “2012 Florida Action”) in the U.S. District Court for the Southern District of Florida (the “Florida Court”), seeking repayment of advancements in connection with the SEC Investigation. On May 15, 2013, Holley requested advancement from Nipro for the ongoing SEC Action and partial indemnification for the Criminal Action. Nipro, however, denied Holley’s request. On June 19, 2013, the Florida Court dismissed the 2012 Florida Action based on a pleading error. On April 21, 2014, Nipro filed another action against Holley in the Florida Court (“Florida I”), again seeking repayment of advancements. On June 17, 2014, the Florida Court dismissed Florida I again on procedural grounds. On the same day, Nipro filed another action in the Florida Court (“Florida II”) with the same complaint as that of Florida I. On June 20, 2014, Holley requested an advancement of his expenses for Florida II; Nipro denied this request. Holley eventually filed this suit seeking advancement from Nipro for the SEC Action, Florida I, and Florida II, in addition to various other claims. Nipro subsequently moved to dismiss or stay this suit in favor of Florida II. Shortly thereafter, Holley moved for partial summary judgment on his advancement claims.

The Court used the four-factor analysis of McWane Cast Iron Pipe Corp. v. McDowell-Wellman Eng’g Co., 263 A.2d 281 (Del. 1970), to analyze Nipro’s motion to dismiss or stay, and ultimately denied the motion because Nipro failed to meet the four-factor analysis of McWane. First, the Court considered whether Florida II was first-filed. Nipro filed Florida II one month after Holley filed this suit, but Nipro claimed that the complaints in Florida I and Florida II were practically identical, and therefore, the filing date of Florida II should relate back to that of Florida I, making the former first-filed. While the Court stated that there was some support in Delaware case law for Nipro’s claim, it also stated that Nipro perhaps should not be allowed to claim first-filer status given its failure on two prior accounts to comply with the Florida Court’s procedural rules to bring the case at all. The Court did not opine further on this point, however, stating that regardless of the outcome of this particular factor, the remaining three factors of the McWane analysis were unmet. Second, the Court examined whether the actions involved the same parties and issues, and held that, although the parties involved were the same, the issues were not; Florida II concerned indemnification, whereas this suit involved advancement. The Court held that advancement and indemnification are distinct issues, and therefore, the suit at hand was not functionally similar to the issues raised in Florida II. Third, the Court considered whether the Florida Court could provide prompt and complete justice to Holley’s current claims in this suit. The Court noted that Nipro had made several procedural mistakes in asserting its claims in the Florida Court over the last two years, and given the Florida Court’s dismissal of the 2012 Florida Action and Florida I, the Court was uncertain as to whether Florida II would adequately address Holley’s current claims regarding advancement. Lastly, the Court considered whether a balance of harms favored staying or dismissing this action. The Court indicated that, in general, claims for advancement should not be stayed or dismissed in favor of prior related pending litigation in another jurisdiction, and also that the defendant must present a compelling explanation to stay an advancement case, which was not provided in this instance. In balancing the harms, the Court held that the Holley’s interests at stake outweighed those of Nipro.

The Court then turned to Holley’s motion seeking partial summary judgment regarding advancement and his fees on fees for this action. In this instance, Holley’s rights to advancement were derived from an indemnity agreement and HDI‘s Certificate of Incorporation, both of which provided Holley with broad mandatory advancement rights.

Nipro argued first that Holley was not made a party to the SEC Action “by reason of the fact” that he was an officer or director of HDI as required by the indemnity agreement and the Certificate of Incorporation, and thus, was not entitled to advancement. The Court held that, in this case, the “reason of the fact” analysis required looking to the allegations of the SEC’s complaint in the SEC Action, and because the SEC complaint focused on Holley’s position as chairman, the Court held that the “reason of the fact” criterion was met. Nipro also argued that Holley acted in his personal, rather than corporate, capacity. The Court, however, indicated that the line between personal and corporate capacity in advancement cases is generally drawn in favor of advancement, and also stated that when a defendant uses information obtained in his corporate capacity, his actions qualify as being asserted “by reason of the fact” of the corporate capacity. Thus, the Court held that Holley was a party to the SEC Action “by reason of the fact” that he was a director of HDI.

Nipro’s main argument against Holley’s motion was that there could be no advancement where indemnification was impossible, and that indemnification was indeed impossible in this case due to a carve-out in the indemnification agreement that precluded indemnification for violations of insider trading law. However, the Court disagreed, stating first that indemnification and advancement were distinct legal actions, and the right to one was not dependent on the right to the other. Second, the Court held that Nipro wrongly interpreted the carve-out provision to preclude indemnification of any claims for a violation of the insider trading laws; while Nipro argued that this carve-out precluded any claim for an alleged violation, the Court held that the carve-out precluded only actual violations of insider trading laws. Third, while Nipro argued that Holley’s guilty plea on insider trading charges in the Criminal Action indicated that he could not be indemnified in the SEC Action, the Court held that Holley might still be successful in the SEC Action on other grounds. Lastly, the Court held that Holley might still be partially indemnified.

Nipro also argued that the undertaking Holley provided for the SEC Investigation did not carry over to the SEC Action. The Court disagreed, holding that the initial undertaking was indeed sufficient, as the SEC Action was a continuation of the SEC Investigation. Nipro also argued that any attempt by Holley now to provide the undertaking for the SEC Action was barred by laches. The Court rejected this argument, explaining that the procedural history of Holley’s litigation, which included advancements for some period of time followed by a stay of the SEC Action, explained the delay. Nipro also argued that allowing Holley to obtain advancement violated public policy because Delaware law prohibits indemnification for a party not acting in good faith or in the best interests of the corporation. Given the guilty plea, Nipro claimed that Holley acted willfully and not in the best interests of HDI. The Court responded by again pointing out that indemnification and advancement were distinct issues. If the SEC wins its suit against Holley, then the state-of-mind limitations will be relevant, but if Holley succeeds, his state of mind is irrelevant and he will not have to repay the advancement.

Holley also moved for summary judgment on his claim for advancement as to Florida II. The Court held that, given Nipro’s apparent reliance on the same arguments it used for the SEC Action, Holley was entitled to advancement for Florida II on the Court’s same logic as described above.

Finally, because the Court (1) denied Nipro’s motion to dismiss or stay the action and (2) granted Holley’s motion for partial summary judgment regarding his right to advancement in the SEC Action and Florida II, the Court held that Holley was entitled to all reasonable fees on fees incurred in this suit regarding his claims for advancement.

George H. Holley v. Nipro Diagnostics, Inc., C.A. No. 9679-VCP (December 23, 2014) (Parsons, V.C.)

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