Chancery Court Preserves Advancement for Corporate Officers Despite Exclusive Remedies and Seller Release Provisions in Stock Purchase Agreement

By Whitney Smith and Dean Brazier

In Mark S. Davis, et al. v. EMSI Holding Company, C.A. No. 12854-VCS (Del. Ch. May 3, 2017) the Delaware Chancery Court granted a motion for summary judgment brought by former officers of the defendant (“EMSI”) seeking advancement of legal fees for their defense in a related action, EMSI Acquisition, Inc. v. Contrarian Funds, LLC, et al., C.A. No. 12648-VCS (Del. Ch. May 3, 2017).  In granting the motion, the Court considered whether the plaintiffs had waived or released their right to advancement in the exclusive remedies provision or the seller release provision of the Stock Purchase Agreement (“SPA”) entered into in connection with the sale of EMSI.  The Court concluded that the SPA provisions did not waive or release the officers’ right to advancement of defense costs under EMSI’s bylaws and a sufficient nexus existed between the plaintiffs’ role as former officers and the claims in EMSI Acquisition requiring their defense.

In late 2015, EMSI Acquisition, Inc. (“Buyer”) bought EMSI from the selling stockholders (“Sellers”).  Not long after the closing of the transaction, however, the Buyer sued the Sellers in EMSI Acquisition alleging that EMSI’s employees engaged in a variety of fraudulent accounting schemes that inflated the apparent value of EMSI.  The Sellers included the plaintiffs here, Mark Davis and Robert Brook, who in turn sued EMSI for advancement of legal costs relating to their defense in EMSI Acquisition.  EMSI claimed that Davis and Brook were not entitled to advancement of their defense costs in EMSI Acquisition on three independent grounds: (i) the officers, as Sellers pursuant to the SPA, waived their right to advancement; (ii) the officers released any potential claims for indemnification and advancement in the SPA; and (iii) the Buyer sued Davis and Brook as Sellers, not as officers and directors of EMSI.

The Court first assessed EMSI’s argument that the exclusive remedies provision in the indemnification section of the SPA effected a waiver of Davis and Brook’s right to advancement of defense costs.  The exclusive remedy provision (Section 10.10(a) of the SPA) provided, in part, that the “the sole and exclusive remedy . . . for any . . .  claims arising in connection with any of the Transaction Documents . . . shall be indemnification in accordance with this Article X” and “Sellers waive, release, and agree not to assert . . . to the fullest extent permitted by applicable Law, all other remedies, whether common law or statutory or at equity.”  EMSI argued that advancement was implicitly included among the “other remedies” waived by the SPA.  The Court, however, drew a distinction between a remedy sought by a party prosecuting an affirmative claim under the SPA and pre-existing, external rights used by a party defending against that claim.  On this basis, the SPA does indeed restrict parties to indemnification when seeking an affirmative remedy under the SPA, but not where, as here, Davis and Brook sought to enforce a right granted by the EMSI bylaws to advancement of legal fees in connection with defending against the Buyer’s claim for indemnification under the SPA.

The Court then assessed EMSI’s argument that the seller release provision of the SPA released Davis and Brook’s claim for advancement of defense costs.  In Section 6.5 of SPA, “the Sellers . . . release[d], waive[d], and discharge[d], . . . any and all claims, obligations, suits, judgments, damages, debts, rights, . . . that the Releasing Parties has, had, or may have against the EMSI Entities, Buyer and the Receiving Party.”  Section 6.5 carved-out from that release, however, “any right to indemnification that any Releasing Party has, in his or her capacity as an officer or director (or former officer or director), under the Governing Documents of the applicable EMSI Entity.”   EMSI proffered two arguments here.

First, EMSI argued that any advancement right carved-out by Section 6.5 did not apply to first-party claims based on the SPA.  In other words, the officers only maintained their advancement right in the cases where a third party unrelated to the SPA sued the officers.  EMSI claimed that interpreting the exception in Section 6.5 as applying to first-party claims related to the SPA would render Sections 10.10(a) (exclusive remedies) and Section 12.3 (each party to pay its own attorneys’ fees) meaningless.  The Court rejected EMSI’s interpretation pointing out that the seller release provision itself was limited to a release of first-party claims between the sellers and EMSI and the carve-out was intended to be a subset of those first-party claims that otherwise would have been released.

EMSI argued in the alternative that, if the seller release provision itself was not a waiver of Davis and Brook’s right to advancement, then the carve-out to the seller release was not broad enough to preserve the right to advancement of defense costs because the carve-out specified only indemnification rights under EMSI organizational documents and not advancement, which Delaware courts have specified are two distinct rights.  The Court did not agree, reasoning that the carve-out language preserved indemnification rights created by EMSI’s bylaws, and the bylaws in turn provided that “[t]he right to indemnification . . . shall include the right to be paid by [EMSI] the expenses (including attorneys’ fees) incurred in defending any such Proceeding in advance of its final disposition.”  This conclusion is consistent with the precedent laid out in Sodano v. American Stock Exchange LLC, 2008 WL 2738583 (Del. Ch. July 15, 2008).

The Court then addressed EMSI’s final defense claiming that Davis and Brook were not being sued “by reason of” their capacities as former officers and, therefore, were not able to invoke the preserved right to advancement.  The Court cited Homestore, Inc. v. Tafeen, 888 A.2d 204 (Del. 2005) and Paolino v. Mace Sec. Intern., Inc., 985 A.2d 392 (Del. Ch. 2009) for the proposition that there must be a nexus between the corporate role and the present claim and such a nexus can be very broad.  The Court then noted that Davis and Brook “will be required to defend their actions as officers and directors of [EMSI] and their alleged intentional abuse of their corporate powers” in EMSI Acquisition, the underlying action, and on that basis, determined that a sufficient nexus existed.

Mark S. Davis, et al. v. EMSI Holding Company, C.A. No. 12854-VCS (Del. Ch. May 3, 2017)

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