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January 2, 2013

LITIGATION AND ENFORCEMENT

DIRECTORS AND OFFICERS-Delaware Chancery Court Upholds Board's Refusal to Advance Director's Legal Fees

By Mark S. Nelson, J.D.

The Delaware Chancery Court has upheld a corporate board's decision not to advance legal fees to one of its directors (Miller v. Palladium Industries, Inc., December 31, 2012, Noble, J.). The case arose from an earlier action for alleged breach of fiduciary duty, misappropriation, waste, and conversion against David F. Miller, III, in his capacity as president, CEO, and director of Palladium Industries, Inc. (Palladium) and its operating subsidiary, VisionAid, Inc. (VisionAid) Miller sued Palladium after the firm's board refused to advance his legal costs in the prior case. The chancery court held that Palladium need not advance Miller's costs and granted Palladium's motion for judgment on the pleadings.

Palladium's amended bylaws provided in Article X, Section 1 that each person who is or was a director or officer of the firm "shall be indemnified" in advance of a final disposition of certain proceedings. However, this requirement is subject to Article X, Section 5, which purported to limit the indemnification right. Section 5 stated that a director's legal costs "shall" be advanced "unless otherwise determined by the Board of Directors in the specific case..." The question for the court was whether Section 5 made the seemingly mandatory advancement provision subject to the board's taking action to deny an advancement demand.

The chancery court observed that advancement of legal costs is not required by the Delaware General Corporation Law, but companies may choose to advance these costs. Delaware policy encourages firms to advance costs to aid recruitment of corporate talent. However, a corporate board must exercise its business judgment regarding the advancement of legal costs unless its bylaws or a contract require advancement.

Here, the chancery court said Palladium's bylaws unambiguously required advancement absent a contrary directive. As an example, the court said that failure by Palladium to act in a timely manner would render an advancement request mandatory, but in the instant case, Palladium acted in a timely manner (within 30 days after Miller's request). Palladium said it denied Miller's demand because: (1) advancement would deprive Palladium and VisionAid of operating funds; (2) Palladium's impaired finances and lack of operating funds were "due in large part" to Miller's alleged misconduct; (3) Miller likely would be required to repay advanced costs; (4) Miller likely could not repay advanced costs; and (5) advancement was against Palladium's interests.

The chancery court also rejected Miller's argument that the chancery court's 2009 decision in Stockman v. Heartland Industrial Partners, L.P. required a different result. In that case, a corporation claimed that advancement was not required absent the general partner's prior written approval, but the court said that general partner approval meant a determination that an advancement demand met form and other technical requirements. By contrast, Palladium's bylaws made the advancement provision subject to the later provision allowing the board to deny advancement. As a result, concluded the court, unlike the Stockman bylaws, Palladium's bylaws cannot be interpreted to give separate meaning to the "unless" clause.

The case is C.A. No. 7475-VCN.

Kathleen M. Miller (Smith Katzenstein & Jenkins LLP) for David F. Miller, III. Stephen C. Norman (Potter Anderson & Corroon LLP) for Palladium Industries, Inc.

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