The issue is called advancement of fees and expenses, and it can make or break a lawsuit for the client, the plaintiff’s counsel, and the business lawyer who had the foresight to include it in the operative contract. Here’s why.
Indemnification for Corporate Agents
Under corporation statutes in Delaware and most other states, when a claim is brought against a corporate employee, officer, or director (“agent”) that arises of out the of agent’s status as employee, officer, or director, if the agent defends the case and wins, the corporation is obligated to reimburse the agent for all attorney’s fees and costs incurred defending the claim.
- This includes all types of claims—e.g., breach of fiduciary duty, sexual harassment, even allegations of criminal misconduct—as long as the claim arises out of the relationship with the corporation.
- The standard for “arises out of” is very broad. Essentially it means that but for the agent’s relationship to the corporation they would not be facing the claim.
- The only other limits are that the agent’s fees and costs must be reasonable, which is also broad and would include the hourly rates of lawyers at a good law firm, and the agent must prevail.
Indemnification Can Be Meaningless Without Advancement
Here’s the rub. To get to the point of prevailing, the corporate agent has to pay the lawyers’ invoices out of her own pocket. That could cost easily tens or hundreds of thousands of dollars. As a result, the right to indemnification is, in many cases, meaningless, unless the agent can convince a lawyer to represent them with the promise of being paid at the end of the lawsuit, assuming the agent prevails. Not many lawyers will take that risk. This is where advancement comes in.
The corporation statutes that provide for indemnification also provide that the corporation may pay for the legal fees and costs of claims against corporate agents as the fees and costs are incurred. This is called permissive advancement, and it enables the folks who run the corporation to pay for the defense costs of themselves and members of their team facing lawsuits, provided that the agent denies the allegations and agrees in writing that she will pay back all of the fees and costs if she loses the lawsuit.
That’s all well and good if the agent is on the good side of the people who run the corporation, but what if that is not the case, such as when it is the corporation making the claim against the agent?
To protect against this situation, and to incentivize qualified people to work for corporations, those same statutes permit corporations to enter into agreements requiring them to pay attorney’s fees and expenses in advance of the conclusion of the lawsuit, as they are incurred. What are the requirements for mandatory advancement?
- The contract must contain clear language requiring advancement.
- The claim must arise out of the agents’ status as corporate agent.
- The agent must deny the claim.
- The agent must agree in writing to reimburse the fees and expenses if they lose the lawsuit.
Mandatory advancement provisions are enforceable in summary enforcement proceedings that can be brought in any state or federal court with jurisdiction; they are often brought in Delaware Chancery Court and federal district courts in Delaware and New York.
Practical Importance of Mandatory Advancement
Litigation about advancement almost always arises when the corporation and the agent have become adverse. In addition to funding the defense of the litigation (and the prosecution of the advancement claim), success on an advancement claim provides a powerful incentive for the corporation to settle or drop the claim against the agent.
There is an extensive body of law on the rights of advancement and indemnification. The prudent client will consult experienced counsel considering such a provision in a contract or when facing a lawsuit involving a corporate agent with allegations of wrongdoing that arose out of their corporate statute. But the main thing for those of us who get paid to spot issues is this: when drafting or reading an indemnification clause in any corporate contract, including not just employment contracts but also purchase and sale contracts, look for the magic language requiring the corporation to advance fees and expenses as incurred. It can make all the difference if the relationship later goes sour.
The lawyers at Steve Harvey Law have extensive experience litigating advancement and indemnification issues. Check out the decision of U.S. District Judge Jed Rakoff in one of our recent cases: Ryu v. Hope Bancorp, Inc., 2018 WL 1989591 (April 26, 2018)