Court of Chancery Clarifies Method of Determining Specific Advancements
By Scott Waxman, Hilda Li, and B. Ashby Hardesty, Jr.
In this case, Vice Chancellor Laster issued a memorandum opinion in Edward M. Weil, et al v. Vereit Operating Partnership, L.P., C.A. No. 2017-0613-JTL, granting partial summary judgment in favor of individual plaintiffs, who served as senior officers and members of the board of directors of Vereit, Inc, (“Vereit”) the sole general partner of Vereit Operating Partnership, L.P. (the “Partnership”).In September 2014, the Audit Committee of the board of directors of Vereit commenced an investigation into alleged financial reporting irregularities at Vereit, which led to a series of internal and government investigations as well as litigations against the plaintiffs. In November 2014, the plaintiffs retained counsel to represent them in the above mentioned investigations and litigations and requested advancements from Vereit. Although the plaintiffs provided documentation to support their advancement requests and sent Vereit monthly invoices, Vereit objected to advancing more than $17 million to the plaintiffs on various grounds including, among other things, inadequate explanations for third party expenses, excessive legal fees, overstaffing, and inadequate description of the work performed. Thereafter, the plaintiffs sought to obtain advancements from the Partnership pursuant to the relevant advancement provisions under the Partnership’s partnership agreement (the “LP Agreement”).
The relevant advancement provisions in the LP Agreement granted mandatory advancement rights to the plaintiffs but limited such rights to persons “made a party to [certain covered proceedings] by reason of its status as . . . a director, manager or member of the [Vereit] or an officer or employee of the Partnership or [Vereit].” Additionally, the provisions limited the amount of advancement to “reasonable expenses.” In interpreting the above provisions, the Court discussed the various issues below.
Advancement is a contractual right. The Court held that limited partnerships have broad power under Section 17-108 of the Delaware Revised Uniform Limited Partnership Act to draft their own indemnification and advancement scheme. Advancement is a contractual right governed by the terms of the operative agreement and the party granting such advancement right cannot unilaterally impose additional terms or conditions on such rights.
Factors to determine whether an individual is party to a proceeding. The relevant advancement provisions require an individual claiming the advancement to be a party to a proceeding, such as the above mentioned internal and government investigations. The Court held that the requirement is clearly met if the party conducting the investigation has said that the individual is a target of the investigation. The Court stated that the requirement would also be met if the party conducting the investigation sought documents or other information from the individual or interviewed the individual. However, the requirement would not be met if an individual only believes that he or she could become a target of the investigation.
The “by reason of” test. The Court held that to meet the “by reason of” test, there must be “a nexus or casual connection” between the underlying proceeding and the function or capacity that the individual performed on behalf of the entity. Therefore the determination normally turns on the pleadings in the underlying litigation. In the words of the Court: “[i]n advancement cases, the line between being sued in [a non-covered] capacity and one’s corporate capacity generally is drawn in favor of advancement with disputes as to the ultimate entitlement to retain the advanced funds being resolved later at the indemnification stage.”
Factors to determine whether particular expenses are advanceable. The Court then turned to the procedure for determining whether particular expenses are advanceable set forth in Danenberg v. Fitracks, Inc. (“Fitracks Procedures”). The Court stated if particular expenses were incurred in defending the indemnitees in both covered and non-covered proceedings, the Court would look at whether such disputed expense would have been incurred even without the non-covered proceedings. If the answer is yes, such disputed expenses are advanceable. If some work relates to both advanceable claims and non-advanceable claims, that work would be entirely advanceable if it would have been done independently of the existence of the non-advanceable claims. As a general rule, any doubts should be resolved in favor of advancement.
The Court further stated that absent “clear abuse,” counsel’s good faith certification is sufficient to support an award of advancement. If a particular defense benefits the indemnitee and other defendants but the indemnitee would have undertaken it himself or herself without other defendants, then all related fees and expenses would be advanceable. If a particular defense only partially benefits the indemnitees, counsel must make a good faith allocation of the amount of fees and expenses that the indemnitee would have incurred if he were the sole defendant. If a defense only benefits third-party defendants other than the parties entitled to advancement, the entity need not advance the related fees and expenses.
Reasonableness of fees. Finally, the Court addressed the issue of the reasonableness of the fees requested for advancement. The Court stated that advancement is a form of contractual fee-shifting and thus subject to rules that govern the interpretation of contractual provisions. When determining what constitutes a “reasonable amount” under a contractual provision, a court will use “the factors set forth in [Section 1.5(a) of] the Delaware Lawyers’ Rules of Professional Conducts” as a framework. As a general rule, a party’s expenses are reasonable if they were “actually paid or incurred, were thought prudent and appropriate in the good faith professional judgment of competent counsel and were charged at rates, or on a basis, charged to others for the same or comparable services under comparable circumstances.” A court shall not second-guess an attorney’s judgment in incurring time and monetary expenses.
Employing the above reasoning, the Court granted granting partial summary judgment in favor of individual plaintiffs and ordered the parties to follow the Fitracks Procedures to determine the specific advancements due.
Edward M. Weil, et al, v. Vereit Operating Partnership, LP, memorandum opinion