Chancery Court Reaffirms Protection of Mandatory Advancement Rights

By: David Forney and Rich Minice

In Nielsen v. EBTH Inc., C.A. No. 2019-0164-MTZ (Del. Ch. Sep. 30, 2019), the Delaware Court of Chancery reaffirmed its standard favoring advancement of expenses to officers or directors of a company where the corporation provides mandatory advancement rights either by its certificate of incorporation (“Charter”) or separate indemnification agreements. The court granted summary judgment in favor of the plaintiffs because they (i) either used their corporate powers or such powers were necessary for the commission of the alleged misconduct in the underlying action; or (ii) the alleged misconduct in the underlying action is inextricably intertwined with the actions taken in the plaintiffs’ former capacities as officers or directors, such that the plaintiffs would necessarily be required to disprove allegations that they acted improperly as such. Advancement is appropriate when either of the two prongs for this nexus test are met.

Andrew Nielsen, Jonathan Nielsen and Michael Reynolds (the “Plaintiffs”), all former directors and officers of EBTH Inc. (the “Company”), are defendants seeking advancement of expenses pursuant to the Company’s Charter and indemnification agreements for a pending suit alleging various breaches of fiduciary duties, unjust enrichment and breach of contract, Light EBTH LLC v. EBTH Inc. et al., 1:19-cv-00011-TSB, (the “Ohio Action”). The underlying action stems from the sale of the Plaintiffs’ personal Company stock to Light EBTH LLC (respectively, “Light” and the “Stock Purchase”), an entity created and owned by various investors for the Stock Purchase. During the Stock Purchase negotiations, Plaintiffs allegedly materially misrepresented the financial status of the Company by manipulating proprietary information of the Company in order to secure a more favorable purchase price. The Stock Purchase included various representations made by the Plaintiffs, who signed the agreement in their individual capacities as sellers. The Company contends that the Plaintiffs are not entitled to advancement of expenses because they acted fraudulently, executed the Stock Purchase in their individual capacity, were motivated by personal greed, and acted outside their official capacity as officers and directors.

An advancement of expense claim arises “by reason of the fact” of a person’s corporate status “if there is a nexus or causal connection between any of the underlying proceedings… and one’s official corporate capacity.” Homestore, Inc. v. Tafeen, 888 A.2d 204, 214 (Del. 2005). “This language has been interpreted broadly, and includes all actions brought against an officer or director for wrongdoing that he committed in his official capacity, and for all misconduct that allegedly occurred in the course of performing his day-to-day managerial duties.” Imbert v. LCM Interest Hldg. LLC, 2013 WL 1934563, at *5 (Del. Ch. May 7, 2013). The requisite nexus “exists if corporate powers were used or necessary for the commission of the alleged misconduct” or the underlying claim is inextricably intertwined with the actions taken in the plaintiffs’ former capacities as officers or directors, such that the plaintiffs would necessarily be required to defend those actions and possibly disprove of allegations that they acted improperly in those capacities. Hyatt v. Al Jazeera Am. Hldgs. II, LLC, 2016 WL 1301743, at *8-9 (Del. Ch. Mar. 31, 2016). The Charter and separate indemnification agreements between the Plaintiffs and the Company each incorporate this standard.

Turning to the first prong of the advancement of expense analysis–whether the Plaintiffs used corporate powers–the court noted that Light’s complaint in the Ohio Action explicitly challenges the Plaintiffs’ conduct as officers or directors of the Company. The court cited specific portions of the complaint in which the Plaintiffs allegedly acted on behalf of the Company and each other. Additionally, Plaintiffs allegedly represented themselves throughout the Stock Purchase negotiations as agents and representatives acting on behalf of the Company. The allegations in the underlying Ohio Action require that the Plaintiffs defend their actions as officers and directors of the Company. Second, the court noted that corporate powers were necessary for the Plaintiffs’ alleged deceptions. Light alleged Plaintiffs manipulated confidential Company information, including Company financial statements, which they had access to and knowledge of by virtue of their roles with the Company. Compounding this implicit knowledge and access, the Company executed the NDA associated with the Stock Purchase negotiations, and therein explicitly authorized Plaintiffs to share confidential information with Light. The court noted that Nielsen executed the NDA as the CEO of the Company, not in his individual capacity. The court found that the Plaintiffs were intimately involved with the Stock Purchase, including through their access and alteration of confidential information “by reason of the fact” of their roles at the Company. Therefore, the Plaintiffs will need to defend Light’s claim that they, as insiders, knowingly provided false or misleading information to Light to secure favorable terms in the Stock Purchase.

The court continued, rejecting the Company’s argument that the Ohio Action only implicates Plaintiffs’ personal contractual obligations to sell Company stock to Light pursuant to the Stock Purchase, and that the Company itself was a “legal stranger” to the transaction. In rare circumstances, expense advancement rights will not attach because the “parties are litigating a specific and personal contractual obligation that does not involve the exercise of… decision-making authority on behalf of the corporation” and the underlying claim “does not have any nexus or causal connection to official duties.” Hyatt, 2016 WL 1301743, at *8 (quotation omitted); Davis, 2017 WL 1732386, at *10 (quotation omitted). However, even if the Plaintiffs had not taken actions in their official capacity as explained above, they are entitled to advancement. Although the Company was not a party to the Stock Purchase, the Ohio Action alleges that by entering into the NDA, the Company anointed Plaintiffs as the exclusive sources of confidential Company information for Light. Thus, as the sole source for confidential information, the Plaintiffs roles as sellers in the Stock Purchase and as directors and officers of the Company were inextricably intertwined. The court noted that this same question was previously answered in Rizk v. Tractmanager, Inc., 2014 WL 5788767 (Del. Ch. Nov. 5, 2014), and the court reaffirms the “inextricably intertwined” advancement basis here. The Company failed to show that Light’s claims in the Ohio Action clearly involve a specific and limited contractual obligation without any nexus or causal connection to official duties.

Finally, and as an alternative, the Company argued that the nature of some claims at issue in the Ohio Action–specifically breach of contract and unjust enrichment–preclude advancement of expenses because they are not premised on Plaintiffs’ fiduciary duties to the Company. The court rejected this argument because the “by reason of the fact” standard can be met even where the cause of action does not specify a breach of fiduciary duty, but does implicate the same facts and actions. Here, the alleged misconduct for these claims is the same as the conduct through which Plaintiffs allegedly misused their corporate powers. Because Plaintiffs will be required to defend their actions as officers and directors of the Company, they are entitled to advancement for all claims associated with the alleged intentional abuse of corporate powers.

The Court then ruled that the Plaintiffs were entitled to fees-on-fees in prosecuting the advancement suit, because they successfully prosecuted in full the advancement suit.