Chancery Court Holds that Subsidiary must Advance Legal Fees to Parent Company to Cover Costs from Separate Suit by Subsidiary Against Parent Company
By Scott E. Waxman and Mick G. Pence
In International Rail Partners, LLC v. American Rail Partners, LLC, C.A. No. 2020-0177-PAF (Del. Ch. November 24, 2020) plaintiffs International Rail Partners LLC, Boca Equity Partners LLC, Patriot Equity LLC, and Marino (“Plaintiffs”) and defendant American Rail Partners LLC. (“Company”) both filed motions for judgment on the pleadings. The Delaware Court of Chancery (“Court”) granted the Plaintiffs’ motion that sought advancement of expenses incurred while defending an action filed against them by the Company in the Delaware Superior Court. The Court held that the parties’ Limited Liability Company Agreement (“LLC Agreement”) unambiguously provided that the Company must advance the Plaintiffs’ fees incurred in defending the Superior Court action.
The Company is a Delaware limited liability company with two members: plaintiff International Rail Partners LLC (“IRP”) and non-party Newco SBS Holdings LLC (“SBS”). The Company is governed by the LLC Agreement, which identifies plaintiff Marino as the chairman of the Company’s board of directors and as the Company’s chief executive officer. Marino also controls plaintiffs Boca Equity Partners LLC and Patriot Equity LLC, and is IRP’s chief executive officer. In July 2019, IRP and SBS terminated their management agreement after disagreeing over the management of the Company. In February 2020, the Company filed a complaint against the Plaintiffs in the Delaware Superior Court alleging, among other things, that IRP and Marino engaged in mismanagement and unjustly enriched Marino and his affiliates at the expense of the Company. In March 2020, the Plaintiffs filed a complaint pursuant to Section 18-108 of the Delaware Limited Liability Act (“LLC Act”), seeking advancement and indemnification to cover the claims asserted in the Superior Court action, the legal fees of this case, and pre- and post-judgment interest from the date of the Plaintiffs’ first demand for advancement and indemnification.
The Company refused to advance the Plaintiffs’ fees and expenses, arguing that the advancement and indemnification provisions of the LLC Agreement did not expressly state that they applied to claims filed by the Company against covered entities under the LLC Agreement, which the Company referred to as “first-party claims.” The Company distinguished “first-party” claims from “third-party claims” (i.e. claims not brought by the Company), which it argued were the only claims covered by the LLC Agreement. The Company relied on a series of Delaware cases to support its first-party/third-party claim distinction argument.
In reviewing the parties’ motions, the Court stated that a motion for judgment on the pleadings may be granted when no material issue of fact exists between the parties. The Court noted that advancement cases are particularly appropriate for judgment on the pleadings because they principally involve the question of whether claims pled in a complaint trigger a right to advancement under the terms of a corporate instrument. The parties’ motions in this case turned on the construction of the LLC Agreement, which the Court analyzed using the same principles generally used when interpreting other contracts.
The Court began by reviewing Section 18-108 of the LLC Act (which broadly authorizes a limited liability company to provide for indemnification and advancement) and the LLC Agreement’s indemnification and advancement provisions to hold that the Plaintiffs were entitled to advancement under the terms of the LLC Agreement. First, the Court found that the Company’s argument was not based on a plain reading of the LLC Agreement, which specified in relevant part that “[t]he Company shall indemnify, defend and hold harmless each Covered Person against any losses [and] claims . . . (including all reasonable fees and expenses of counsel) . . . arising from any and all claims . . . actions, suits or proceedings . . . in connection with any matter arising out of or in connection with the Company’s business or affairs, or this Agreement or any related document.” The Company did not dispute that the Plaintiffs’ were “covered persons” under the LLC Agreement.
Next, the Court addressed the line of cases used by the Company to support its argument that the distinction between first-party and third-party claims is applicable to the LLC Agreement. These cases all stood for the proposition that Delaware courts should not turn standard indemnity provisions in commercial contracts into fee-shifting provisions because doing so would gut the American Rule that litigants must pay their own attorneys’ fees. The Company did not cite a single case applying the first-party/third-party distinction to an indemnification or advancement provision in a certificate of incorporation, corporate bylaws, limited partnership agreement, or limited liability company agreement. The Court explained that unlike commercial contracts, indemnification and advancement provisions in LLC agreements are derived from clear statutory authority and apply much more broadly. That statutory authority, Section 18-108 of the LLC Act, allows a limited liability company to provide for indemnification as to “any and all claims and demands whatsoever,” subject to the restrictions in a limited liability company agreement. The Court also noted that the Company’s argument ran contrary to the strong public policy favoring advancement and indemnification in corporate governing documents. As such, the Court refused to apply the first-party/third-party distinction featured in the Company’s line of cases to the LLC Agreement.
Finally, the Court rejected the Company’s argument that two fee-shifting provisions in other sections of the LLC Agreement were further support for not construing the LLC Agreement’s indemnification and advancement provisions as applying to first-party claims. The Court explained that the first fee-shifting provision expressly applied only to members of the Company, and that the Company’s interpretation of the other fee-shifting provision ignored the breadth of the LLC Agreement’s indemnification and advancement provisions and would result in an unreasonable construction of the LLC Agreement. Because the Court concluded that the Plaintiffs were entitled to advancement, the Court also held that the Plaintiffs were entitled to their reasonable attorneys’ fees and expenses in this case too.