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Court Rules that Separate Instruments Grant Separate Advancement Rights

Authors: James H. S. Levine, Joanna J. Cline, Douglas D. Herrmann and Christopher B. Chuff

8/03/2016
Court Rules that Separate Instruments Grant Separate Advancement Rights

Companies seeking to limit advancement must do so consistently across all sources conferring those rights or risk being liable for advancement even where they sought to limit or condition the right, but failed to do so in all instruments.

Reprinted with permission from the August 3, 2016 edition of the Delaware Business Court Insider. © 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382).

Advancement of legal expenses is a frequent subject of litigation in the Delaware Court of Chancery. Companies offer advancement to induce individuals to serve as officers or directors, but sometimes balk when the officer or director seeks to exercise their advancement right. Most frequently companies argue that the officer or director is not entitled to advancement because either the claim falls outside the parameters of the instrument that awards advancement or any reasonable interpretation of such instrument absolves the entities' advancement obligation. In a recent case, Narayanan v. Sutherland Global Holdings, C.A. No. 11757-VCMR (July 5), Vice Chancellor Tamika R. Montgomery-Reeves rejected a corporation's argument that a provision of one instrument providing for advancement limited the application of another advancement obligation that did not contain a similar limitation provision, and ruled that each instrument established an independent right to advancement.

Background

Plaintiff Muthu Narayanan served as a director and officer of Sutherland's India subsidiary as well as a director of two additional companies formed to develop real estate in India, one owned by the subsidiary and the other owned by Sutherland's chairman, chief executive officer, and controlling stockholder. Narayanan oversaw the advancement of millions of dollars to two land aggregators to acquire real estate on behalf of each entity. One of the development projects failed, however, when the land aggregator was imprisoned on conspiracy charges arising from similar work performed for another client, and failed to repay the money advanced to him to acquire properties for Sutherland. The controlling stockholder then started an internal investigation into the land deals which ultimately questioned Narayanan's credibility.

The following year, Narayanan determined to retire and sought to exercise his Sutherland stock options, but the controlling stockholder conditioned the exercise on the completion of the real estate development projects. Unable to recover payment for his exercised shares, Narayanan sued Sutherland in the U.S. District Court for the Western District of New York (the New York action). In an effort to set off any amounts potentially owed to Narayanan, Sutherland asserted a counterclaim that Narayanan had not fully cooperated with Sutherland's efforts to collect the funds advanced to the land aggregator, that Narayanan had breached his fiduciary duties to the company in connection with the development transactions, and that Sutherland had suffered damages exceeding the amount Narayanan sought to recover. Sutherland's controlling stockholder also initiated criminal complaints against Narayanan in India alleging similar claims. Narayanan sought advancement of expenses incurred defending the New York setoff defense and counterclaim and the Indian criminal proceedings.

Narayanan's Rights to Advancement

Sutherland's certificate of incorporation permitted the company to indemnify and advance expenses to directors through a variety of means, including bylaw provisions and separate agreements. Sutherland's bylaws provided for advancement of expenses and also explained that the indemnification and advancement rights were not "exclusive of any other rights which such person may have or hereafter acquire under ... the certificate of incorporation, these bylaws, [or an] agreement." The bylaws also obligated Sutherland to advance legal expenses incurred to Narayanan if he served at Sutherland's request as a director, officer, employee or agent of another entity.

Narayanan and Sutherland also entered into an indemnification agreement, effective the same date as the bylaws, that provided customary indemnification rights to Narayanan in connection with claims brought against him in connection with his duties as a Sutherland director or officer. The indemnification agreement also obligated Sutherland to advance expenses to Narayanan and contained a nonexclusivity clause similar to the company's bylaws. Unlike the bylaws, however, the indemnification agreement required Narayanan to cooperate and provide information to Sutherland in connection with claims asserted against him.

Sutherland argued that Narayanan was not entitled to advancement under the bylaws because he failed to cooperate with the land aggregator investigation. Sutherland asserted that because the bylaws and indemnification agreement were entered into contemporaneously, they should be read conjunctively and that the cooperation provision was a condition precedent to Narayanan's right to advancement under either document. Narayanan argued that the documents should be read disjunctively as separate bases for indemnification. Sutherland also disputed whether Narayanan served as a director of the entity owned by the controlling stockholder at Sutherland's request or for his own personal benefit.

Separate Instruments Should be Read Disjunctively

Montgomery-Reeves held that Section 145(f) of the Delaware General Corporation Law (DGCL) makes clear that the "indemnification and advancement rights under the DGCL are not exclusive of any additional indemnification and advancement rights a corporation chooses to provide through a separate instrument." She cited Chancellor Andre G. Bouchard's ruling in Charney v. American Apparel, C.A. No. 11098-CB (Sept. 11, 2015), "for the proposition that the unavailability of advancement under one source of rights does not foreclose the possibility of advancement under another."

She concluded that although the bylaws and indemnification agreement shared an effective date, the nonexclusivity provisions in each clarified the parties' intent that each instrument would provide rights and obligations independent of the other. Montgomery-Reeves further noted that had the parties intended the instruments to operate conjunctively, they could have easily included language to that effect.

Montgomery-Reeves also rejected Sutherland's argument that the court should deny Narayanan advancement for the India criminal proceedings because his activities were outside the scope of his advancement rights. The relevant inquiry was whether Narayanan was serving as a director of another company at Sutherland's request, and the court concluded that he was. The bylaws thus obligated Sutherland to advance Narayanan's expenses in responding to Sutherland's setoff defense and counterclaim in the New York action, and in the India criminal proceedings.

Conclusions

Narayanan reaffirms that principle that a single source providing advancement is sufficient to confer that right, and that the Court of Chancery will read separate instruments disjunctively when appropriate. Companies seeking to limit advancement must do so consistently across all sources conferring those rights or risk being liable for advancement even where they sought to limit or condition the right, but failed to do so in all instruments.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.