Advancement in Action: LLC Manager Wins Payment for Litigation Costs

| Jason M. Knott

Earlier this week, we outlined the rights of indemnification and advancement, and discussed how those rights can hinge on the statutory law governing a corporation and the private agreements that companies enter into with their officials.  In this post, we review a recent decision to see how these principles apply in real life.

The decision comes from Vice Chancellor Sam Glasscock III of the Delaware Court of Chancery.  Because many companies are incorporated in Delaware, the Delaware courts handle some of the most preeminent disputes involving corporate law, and they have significant experience addressing issues of indemnification and advancement. 

The Vice Chancellor’s opinion illustrates a judicial view that companies sometimes agree to broad rights at the outset of an employment relationship, but then seek to back away from those agreements once a dispute arises.  He wrote:

It is far from uncommon that an entity finds it useful to offer broad advancement rights when encouraging an employee to enter a contract, and then finds it financially unpalatable, even morally repugnant, to perform that contract once it alleges wrongdoing against the employee.

Vice Chancellor Glasscock’s ruling also shows how courts will review the governing statutes and agreements in order to decide whether a company’s denial of advancement is legally justified.

This particular dispute, Fillip v. Centerstone Linen Services, LLC, 2014 WL 793123 (Del. Ch. Feb. 20, 2014), involved Karl Fillip, the former CEO of Centerstone.  Fillip resigned, claiming that he had “Good Reason” for the resignation under his employment agreement and therefore was entitled to receive certain bonuses and severance pay.  When Centerstone wouldn’t pay up, Fillip sued it in Georgia state court, alleging breach of contract and also seeking a declaratory judgment that restrictions in his employment agreement were invalid.  Centerstone then filed counterclaims, which triggered a response from Fillip for advancement of funds to defend against those claims.

Centerstone, as you might imagine, was not happy about this turn of events.  It refused his request, but also said it would withdraw certain counterclaims because it didn’t want to pursue claims “that could potentially trigger an obligation by Centerstone to pay Mr. Fillip’s attorney’s fees and costs in defending them.”  Dissatisfied, Fillip sued in Delaware for advancement of his fees.

In addressing the dispute over advancement, the Vice Chancellor first examined the governing Delaware law, Section 18–108 of the Delaware Limited Liability Company Act.  That section provides that a limited liability company may have the power to indemnify and hold harmless its members and managers “from and against any and all claims and demands whatsoever.”  The Delaware Court of Chancery, wrote the Vice Chancellor, has “made clear that § 108 defers completely to the contracting parties to create and delimit rights and obligations with respect to indemnification and advancement.”

Thus, to resolve this dispute, the Vice Chancellor had to rely on the specific agreements that Centerstone adopted.  Both parties agreed that Article 3.7 of the company’s LLC Agreement was the governing provision.  That article stated:

The Company shall indemnify, defend and hold harmless each Manager and Officer for all costs, losses, liabilities, and damages whatsoever paid or incurred by such Manager or Officer in the performance of his duties in such capacity, including, without limitation, reasonable attorney’s fees, expert witness and court costs, to the fullest extent provided or permitted by the Act or other applicable laws. Further, in the event fraud or bad faith claims are asserted against such Manager or Officer, the Company shall nonetheless bear all of the aforesaid expenses subject to the obligation of such Manager or Officer to repay all such expenses if they are finally determined to have committed such fraud or bad faith acts.

Even though the article did not use the word “advancement,” Fillip argued that it required the company to advance him his reasonable attorneys’ fees for claims asserted against him.  Centerstone argued that the article only mandated advancement for “fraud or bad faith claims,” since that sentence was the only one that discussed repayment of the expenses by the manager or officer.  It said that the first sentence addressed only indemnification, which, as we discussed earlier this week, involves reimbursement of fees, not payment in advance. 

The Vice Chancellor parsed the language of Article 3.7, and found that it unambiguously supported Fillip.  The first sentence said that Centerstone would “defend” its managers and officers.  Centerstone’s meaning, said the Vice Chancellor, would render this language meaningless.  Further, although providing a defense is not necessarily synonymous with advancement, the second sentence made it clear that advancement is precisely what was contemplated.  It would also be contrary to common sense to find that the agreement only provided for advancement when the company brought claims of fraud or bad faith against its managers or officers, and not when the company brought claims based on “less culpable acts.” 

Finally, the Vice Chancellor concluded that the language providing indemnity for claims based on the “performance of [Fillip’s] duties” had a similar meaning to the Delaware corporate statutes allowing indemnification and advancement for claims brought “by reason of the fact” of an employee’s position.  As a result, the use of the “performance” language did not narrow Fillip’s rights beyond what was typical under Delaware law.