CHANCERY COURT FINDS THAT ALLEGATIONS RELATED TO POST-SEPARATION USE OF CONFIDENTIAL INFORMATION LEARNED PRE-SEPARATION WARRANT ADVANCEMENT

By: Scott Waxman and Calvin Kennedy

In Ephrat v. medCPU, Inc., C.A. No. 2018-0852-MTZ (Del. Ch. June 26, 2019), the Court of Chancery found that conduct occurring after Eyal Ephrat and Sonia Ben-Yehuda (together, “Petitioners”) left their positions warrants advancement provided that such conduct was related to Petitioners’ use of confidential information learned in an official capacity with medCPU, Inc. (“medCPU” or the “Company”). However, the Court held that allegations related to Petitioners’ breach of personal contractual obligations do not warrant advancement. Lastly, the Court held that Petitioners did not release their advancement rights by releasing all claims related to their “employment” with the Company.

Petitioners founded medCPU in 2008 and served as directors, officers, employees, and agents of medCPU until 2016. Per medCPU’s certificate of incorporation (the “Charter”), medCPU, to the fullest extent permitted by Section 145 of the DGCL, would indemnify and advance expenses “to any and all persons whom it shall have power to indemnify and advance expenses to….” In 2012, Petitioners entered into loyalty agreements in which they agreed, upon leaving the Company, to not use or disclose the Company’s confidential information, to return all medCPU documents and property, to not compete with medCPU through other employment for 12 months, and to refrain from contacting medCPU’s employees, clients, or potential clients.

When Petitioners left medCPU in 2016, they entered into separation agreements in which medCPU agreed to provide Petitioners with twelve months of separation payments, which the Company was entitled to cease if Petitioners breached their loyalty or separation agreements, and indemnification “to the fullest extent permitted by the Company’s articles of incorporation and/or bylaws….” In return, Petitioners agreed to release “any and all claims for counsel fees and costs” against medCPU “arising out of [their] employment with or separation from the Company….”

In 2017, Petitioners sued medCPU for breaching the separation agreements by ceasing to pay the promised separation payments. The Company stated that it ceased such payments because Petitioners breached their loyalty and separation agreements by forming a competing entity at the end of 2016. The Company brought six counterclaims against Petitioners related to the formation of the entity, Petitioners’ contact of medCPU clients and employees, and the misappropriation of medCPU information. Toward the end of 2018, Petitioners sued for advancement and indemnification under the Charter to cover defense expenses related to medCPU’s counterclaims, and the parties’ cross-moved for summary judgment.

Applying the language of the Charter and Section 145 of the DGCL, the Court found that medCPU’s advancement obligations ran to directors, officers, employees, and agents, and would continue to these individuals after they had ceased serving in any of these roles. The Court applied the “by reason of the fact” standard, and stated that an advancement claim arises “‘by reason of the fact’ of a person’s corporate capacity ‘if there is a nexus or causal connection between any of the underlying proceedings contemplated by section 145(e) and one’s official corporate capacity.’” Relying heavily on prior precedent, the Court held that “allegations relating to post-separation use of confidential information learned pre-separation are ‘by reason of the fact’ of Petitioners’ position.” The Court then applied this standard to medCPU’s various claims and held that claims for “retaining and failing to return medCPU emails,” “possession and failing to return medCPU Corporation Documents and Property…,” “possessing, using and/or misappropriating medCPU’s confidential and proprietary information,” and “misappropriation of confidential information and trade secrets…” all warranted advancement because the confidential information allegedly used was obtained “by reason of the fact of their service to medCPU….” In contrast, the Court held that claims related to competitive activities, including working for and soliciting customers on behalf of a company competing with medCPU, contacting medCPU employees, and accessing medCPU’s computer or electronic communications systems did not warrant advancement because Petitioners took said actions after leaving medCPU and did not use confidential information, thus creating no nexus or causal connections between these actions and Petitioners’ roles at medCPU. The Court lastly addressed advancement for medCPU’s claim for declaratory judgment that the Company was no longer obligated by the separation agreements to pay Petitioners and medCPU’s claim for unjust enrichment. Finding that these claims depended on the same factual allegations as the prior counterclaims, the Court held that advancement was awarded only where the underlying acts depended on the use of “confidential information Petitioners obtained by reason of their service at medCPU.”

On the issue of release of advancement rights, the Court contrasted the language of the release at issue, which only addressed claims “relating to or arising out of Executive’s employment with the Company… or the termination thereof,” with language included elsewhere in the separation agreement which addressed “any claims in any way related to Executive’s employment with the Company or his/her acts or omissions as a director or officer of the Company.” The Court found that the additional language in this latter provision indicated that the former release only released claims related to Petitioners’ status as employees. Consequently, the Court held that the release did not affect the advancement rights provided by the Charter, as they were provided through their roles as officers, directors, employees, and agents.

The Court lastly addressed the issue of whether Petitioners were entitled to receive fees on fees. The Court stated that this determination only required a reasoned consideration of the issues at stake and that they should reflect Petitioners’ level of success. The Court found that the only two issues at stake were whether Petitioners were entitled to advancement and whether they had released such claims for advancement. Reasoning that Petitioners succeeded on half of their advancement claims and had complete success on the issue of release, the Court awarded Petitioners 75% of their fees incurred in pursuing the action at issue.