Show posts for: Indemnification and Advancement

  • Indemnification and advancement are intended to protect individuals from claims asserted against them by shareholders or regulators by virtue of their position with a business entity.  A minimum level of protection is guaranteed by statute for corporate officers and directors.  As we covered in this post, statutory backstops do not exist for employees of alternative business entities, such as limited partnerships (“LPs”), limited liability partnerships (“LLPs”) and limited liability companies (“LLCs”).  Because these alternative business entities offer different advantages, they are chosen as frequently as corporations when a new business is formed.  Therefore, protection of individuals working for these entities will be a growing issue.

    Alternative business entities are desirable because, among other things, the laws under which they are formed are designed to favor flexibility.  Management of an alternative business entity is principally controlled by the operating agreement among the stakeholders, which may contain whatever provisions the stakeholders deem appropriate.  For example, the Delaware Limited Liability Company Act (the “DLLCA”), which governs the formation and operation of Delaware limited liability companies, specifically provides that “it is the policy of this Chapter to give maximum effect to the principal of freedom of contract and to the enforceability of limited liability company agreements.”  6 Del. C.§ 18-1101(b).  The Delaware Revised Uniform Limited Partnership Act (“DRULPA”) has a similar policy statement, 6 Del. C.§ 17-1101(c).  However, if the agreement pursuant to which the alternative entity was formed does not expressly create a right to indemnification and advancement, employees may not have protection or resources to mount a proper defense in a time of need. 

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  • We’ve frequently discussed the well-established indemnification and advancement rights of corporate directors and officers (see here and here, for example).  These benefits protect individuals from claims asserted against them by shareholders or regulators.  Corporate charters and bylaws typically expand these rights to the fullest extent permitted by law, but these provisions are merely an overlay to the statutory provisions which guarantee basic indemnification protections for directors and officers. 

    However, that isn’t the case for alternative business entities, such as limited partnerships (“LPs”), limited liability partnerships (“LLPs”) and limited liability companies (“LLCs”).  Those entities don’t always have a statutory back stop that guarantees indemnification and advancement for their employees.  In recent years, founders are just as likely to choose these alternative structures for their new business as they are to choose the corporate form.  Therefore, protection of these key employees will be a growing issue.

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  • The legal saga of American Apparel and its founder and former CEO, Dov Charney, has more twists and turns than the latest season of Game of Thrones.  We’ve previously blogged about the sundry clashes between the two, including Charney’s ongoing arbitration for severance, the sexual harassment allegations against Charney, and a lender’s threat of default on a major loan after Charney was fired.

    Now, Charney and American Apparel are battling in two separate cases in Delaware Chancery Court.  In the first, American Apparel has sued Charney for violating a standstill agreement by becoming involved in shareholder suits and commenting to the press.  The second case is a follow-on to the first: Charney has sued to force the company to advance his fees for the standstill lawsuit.  In this Game of Thrones, you win or you pay for your defense out of your own pocket.

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  • Companies buy directors & officers (“D&O”) insurance policies with the intention of providing protection for key individuals in a corporate structure.  The recent decision BioChemics, Inc. v. AXIS Reinsurance Co., from the U.S. District Court for the District of Massachusetts, illustrates the importance of the terms of the policy in determining what is covered, what is not, and when you should notify the insurer of a potential claim.

    As we’ve previously discussed, an insurance policy can provide more reliable protection for the indemnification rights of the directors and officers in times of financial distress, because corporations plagued by regulatory or other legal problems frequently suffer financial setbacks.  However, when a corporation is the subject of an official investigation, determining exactly what constitutes the start of a covered “claim” may be a matter of some delicacy. 

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  • Helen of Troy isn’t just a famous mythological beauty.  It’s also a publicly traded maker of personal care products.  And now, it and its directors are defendants in a suit by Helen of Troy’s founder, Gerald “Jerry” Rubin.

    Executives who bring suit against their former employers frequently want to show that they were terminated for reasons other than performance, and Rubin is no different.  In his complaint, as reported by El Paso Inc., Rubin describes the history of Helen of Troy and its staggering growth.  From humble origins – a “wig shop in El Paso, Texas” – Helen of Troy grew into a “global consumer products behemoth, generating revenues in excess of approximately 1.3 billion dollars.”  And then the roof caved in.  Rather than “celebrating [Rubin’s] extraordinary success,” Rubin alleges, Helen of Troy’s directors turned on him in order to save their own skins, and eventually forced him out of the company.

    Why did the directors need to sacrifice Rubin to save their positions?  According to Rubin, the answer lies with an entity called Institutional Shareholder Services (“ISS”).  ISS is a proxy advisory firm that conducts analysis of corporate governance issues and advises shareholders on how to vote.  Because shareholders often follow ISS’s recommendations, it can have substantial influence over the affairs of publicly-traded companies.  Indeed, some participants in a recent SEC roundtable suggested that ISS could have “outsized influence on shareholder voting,” or even that it has the power of a “$4 trillion voter” because institutional investors rely on it to decide how to vote.

    Rubin alleges that if ISS decides a CEO is making too much money, it will demand that the compensation be cut or that the CEO be fired.  If its demand isn’t followed, it will “engineer the removal of the board members through [a] negative vote recommendation.”  Board members then will cave to ISS’s wishes to preserve their own positions.

    Rubin claims that this is what happened in his case.

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  • Last week, we covered the Third Circuit’s decision that Goldman Sachs bylaws didn’t clearly establish a vice president’s right to advancement of his legal fees for his criminal travails.  The vice president, software programmer Sergey Aleynikov, isn’t giving up easily, however.

    Law360 reports that Aleynikov has filed a petition for panel rehearing or rehearing en banc.  In the federal appellate courts, this is a step that parties can take when they disagree with the decision of the three-judge panel that heard their case.  In a panel rehearing, the panel can revisit and vacate its original decision; in a rehearing en banc, the entire Third Circuit could consider the issue.

    Aleynikov contends in his petition that the panel misapplied a doctrine of contractual interpretation called contra proferentem.  In plain English, contra proferentem means that a court will read the written words of a contract against the party that drafted it.  The panel in Aleynikov’s case disagreed as to whether under Delaware law (which governs his dispute), the doctrine can be used to determine whether a person has any rights under a contract.  The two-judge majority said that it can’t, and therefore refused to use the doctrine when it decided whether Aleynikov – as a Goldman vice-president – fell within the definition of an “officer” entitled to advancement under the company’s bylaws.  In dissent, Judge Fuentes asserted that “Delaware has never suggested that there is an exception to its contra proferentem rule where the ambiguity concerns whether a plaintiff is a party to or beneficiary of a contract.”

    In his petition, Aleynikov asks the whole Third Circuit to decide who is right: Judge Fuentes or the majority.  He also cites additional Delaware cases that he says support his position, including one “unreported case” that was brought to his counsel’s attention “unbidden by a member of the Delaware bar who read an article commenting on the panel’s decision in The New York Times on Sunday, September 7, 2014.”  Sometimes, to establish a right to advancement rights, it takes a village.

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  • The case of Sergey Aleynikov, a former vice president at Goldman Sachs, has drawn a lot of media attention, including these prior posts here at Suits by Suits. Aleynikov was arrested and jailed for allegedly taking programming code from Goldman Sachs that he had helped create at the firm. His story even inspired parts of Michael Lewis’s book Flash Boys. A federal jury convicted him of economic espionage and theft, but the Second Circuit reversed his conviction, holding that his conduct did not violate federal law. Now, Aleynikov is under indictment by a state grand jury in New York.

    Unsurprisingly, Aleynikov wants someone else to pay his legal bills – Goldman Sachs. And it is no surprise that Goldman, which accused him of stealing and had him arrested, doesn’t want to bear the cost of his defense. In 2012, Aleynikov sued Goldman in New Jersey federal court for indemnification and advancement of his legal fees, along with his “fees on fees” for the lawsuit to enforce his claimed right to fees. As we discussed in this post, indemnification means reimbursing fees after they are incurred, and advancement means paying the fees in advance. Advancement is particularly important for those employees who cannot float an expensive legal defense on their own dime.

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  • Last week, American Apparel announced that its board had decided to terminate Dov Charney, the company’s founder, CEO, and Chairman, “for cause.”  (We’ve discussed the meaning of terminations “for cause” in prior posts here and here.)  The board also immediately suspended Charney from his positions with the company.  Although the board didn’t initially disclose the reasons for its action, Charney is not new to controversy; in recent years, he has faced allegations of sexual harassment and assault.

    The reasons for Charney’s termination have now become public, and they aren’t pretty.  In its termination letter, available here, the board accuses Charney of putting the company at significant litigation risk.  It complains that he sexually harassed employees and allowed another employee to post false information online about a former employee, which led to a substantial lawsuit.  The board also says that Charney misused corporate assets for “personal, non-business reasons,” including making severance payments to protect himself from personal liability.  According to the board, Charney’s behavior has harmed the company’s “business reputation,” scaring away potential financing sources.

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  • 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.

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  • Imagine sitting on the board of directors of a Fortune 500 company.  You might think it’s a life of corporate jets, cushy board meetings, and prestige.  (Although, the press will tell us, it’s not really that way anymore, thanks to Enron.)  But even if corporate service would truly be the good life, what would happen to you if an aggrieved shareholder sued you for allegedly breaching your fiduciary duties to the company?  Would you have to deplete your bank account to pay expensive lawyers for years of costly litigation?

    The answer is found in the rights of indemnification and advancement (which we have previously discussed here, here, and here in connection with a trade secret case against a Goldman Sachs employee).  Indemnification and advancement are two overlapping, yet different, rights that corporate directors, officers, and employees may have when it comes to the payment of their legal fees in lawsuits brought against them because of their corporate service. 

    Indemnification is the reimbursement of fees after those fees have been incurred.  This right, as the Delaware Supreme Court has written, “allows corporate officials to defend themselves in legal proceedings secure in the knowledge that, if vindicated, the corporation will bear the expense of litigation.”  The words “if vindicated” cannot be emphasized enough – they show that in order to establish a right to indemnification, the officer may have to prevail in the proceeding.

    Advancement, meanwhile, is exactly what it sounds like: payment of fees by the company in advance of the final resolution of the proceeding.  Advancement is an important companion to the right of indemnification, because it provides officials with immediate relief from the financial burden of investigations and legal proceedings.  No vindication required – although the official may have to pay back what she receives if the final decision doesn’t go her way.

    To determine an individual’s right to indemnification or advancement, courts will first look to the statutes governing the business, which may either require or permit those rights.  Because many companies are incorporated in Delaware, we’ll take a look at what Delaware law has to say on this subject.

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As the regulatory and business environments in which our clients operate grow increasingly complex, we identify and offer perspectives on significant legal developments affecting businesses, organizations, and individuals. Each post aims to address timely issues and trends by evaluating impactful decisions, sharing observations of key enforcement changes, or distilling best practices drawn from experience. InsightZS also features personal interest pieces about the impact of our legal work in our communities and about associate life at Zuckerman Spaeder.

Information provided on InsightZS should not be considered legal advice and expressed views are those of the authors alone. Readers should seek specific legal guidance before acting in any particular circumstance.

Contributing Editors
John J. Connolly

John J. Connolly
Partner
Email | +1 410.949.1149


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Andrew N. Goldfarb
Partner
Email | +1 202.778.1822


Sara Alpert Lawson_listing

Sara Alpert Lawson
Partner
Email | +1 410.949.1181


Nicholas DiCarlo

Nicholas M. DiCarlo
Associate
Email | +1 202.778.1835


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