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Advancement Denied to Board Chair Following LLC's Conversion

January 29, 2014
Lewis H. Lazarus
Delaware Business Court Insider

Advancement rights assure directors and officers that if they are sued for  conduct arising out of their company service, the company will pay their  attorney fees and costs as they are incurred. Without advancement rights, many  people would not serve out of fear that their personal assets would be depleted  in defending suits based on their conduct as directors or officers. For that  reason, Delaware courts regularly enforce advancement rights, even after a  finding of criminal guilt at the trial level, until the judgment is final and  all appeals are exhausted. Nonetheless, mandatory advancement rights apply only  if provided by charter, bylaw or contract. The recent case of Grace  v. Ashbridge LLC, C.A. No. 8348-VCN (Del. Ch. Dec. 31, 2013), provides a  cautionary tale that advancement rights that may have existed when the entity  was a corporation do not necessarily survive intact when the entity converts to  a limited liability company.


Plaintiff Charles Grace was the co-trustee of a family trust that held  shares of a Delaware corporation that converted into defendant Ashbridge  Partners LLC, a Delaware limited liability company. Defendant Ashbridge Partners  LLC changed its name to Ashbridge LLC. Grace also served as chair, a member of  the governing boards and a member or shareholder of Ashbridge LLC and its  predecessor, Ashbridge Corp. Upon the filing of an accounting in a Pennsylvania  court by the trustees of the family trust, beneficiaries of that trust filed  objections to that accounting based upon alleged breach of fiduciary duty and  diminution in the value of the trust due to imprudent investments, improper  loans and self-dealing. The Court of Chancery noted that the beneficiaries'  objections to the accounting did not refer to any act taken by Ashbridge LLC.  Grace nonetheless asserted entitlement to advancement from Ashbridge LLC for his  expenses in responding to the objections to the accounting, a failed mediation,  and his Court of Chancery action seeking advancement.

Court of Chancery Rejects Advancement Claim

The primary ground upon which the court rejected Grace's claim for  advancement was that the plaintiff failed to demonstrate that the advancement  provision in the Ashbridge LLC operating agreement applied retroactively to acts  that occurred prior to the formation of Ashbridge LLC. The court so held for  three reasons:

(1) The plain language of the operating agreement defining "company"  "function[ed] prospectively as of the date on which the agreement was executed,"  and the predicate acts for which Grace sought advancement pre-dated the  formation of the LLC.

(2) The plaintiff pleaded no facts in his complaint that related to  Ashbridge LLC.

(3) The court viewed the 2008 conversion of the predecessor corporation into  Ashbridge LLC as a "fundamental change in control" due to the important ways in  which limited liability companies and corporations differ, including the absence  of mandatory statutory indemnification for managers of limited liability  companies who successfully defend themselves. The court thus held that it would  not "impose retroactive obligations on a limited liability company when the  plain language of its operating agreement would not permit predecessor or  affiliate liability and when the indemnification schemes of the predecessor  corporation and successor limited liability company differ."

Lesson Learned

It is important to note that the court was not required to address whether a  successor entity could be liable for advancement based upon the language of a  predecessor's bylaws or operating agreement because the court found that the  plaintiff failed to make well-pleaded allegations that he was entitled to  advancement and indemnification under the predecessor corporation's bylaws. For  practitioners and the directors and officers they represent, this case  demonstrates that parties should not assume that upon conversion of a  corporation into a limited liability company the directors and officers who  become managers are automatically entitled to advancement by the successor  entity for acts taken on behalf of the predecessor corporation. A court is more  likely to find advancement rights in these circumstances if the terms of  advancement and indemnification in the governing documents of the successor  entity are identical to the terms in the predecessor corporation. Even then, a  plaintiff must plead specific facts that he or she complied with the advancement  provisions of the predecessor entity. If a plaintiff cannot so plead, a Delaware  court will not find a right to advancement where, under the governing language  of the relevant advancement provisions, no clear right exists.