Dealing With Disputes Over the Reasonableness of Fees at the Advancement Stage
Like many aspects of Delaware corporate law, the law of a corporate director or officer's entitlement to advancement is not black and white, but it is probably one of the more well established areas of law.
The contours of the law in this area have been addressed so often that members of the Delaware Court of Chancery have on occasion expressed frustration with corporations advancing defenses to mandatory advancement provisions that have little merit to them. (See, e.g., Barrett v. American Country Holdings Inc. a 2008 opinion in which the court wrote: "The accumulation of cases like this, where the stockholders get it coming and going because of the corporation's refusal to honor mandatory advancement contracts, is regrettable, and at some point, a case of sufficient dollar value will arise such that a board is sued for wasting the corporation's resources by putting up a clearly frivolous defense.")
One area of advancement law that is less developed than other areas, but has received increasing attention over the last few years, is how the courts should handle disputes arising out of the ongoing requests for advancement after the entitlement to advancement has been established. In its seminal decision on advancement in Citadel Holding Corp. v. Roven in 1992, the Delaware Supreme Court made clear that (1) Section 145(e) of Delaware General Corporation Law requires only the advancement of reasonable expenses and (2) the person seeking advancement has the obligation to demonstrate the reasonableness of the expenses sought. Though the burden to prove the reasonableness of expenses can be shifted by contract or bylaw, corporations, frustrated by the mandatory advancement language of their own bylaws, often use the reasonableness inquiry as an opportunity to frustrate the advancement right. Although the Court of Chancery has repeatedly stated that Citadel does not require an analytical review of the reasonableness of fees at the advancement stage, corporations still use the excuse as a way to delay or avoid the advancement expense.
When these disputes arise, the Court of Chancery is left in a quandary. How can the court be faithful to the Delaware Supreme Court's holding in Citadel that the party seeking advancement demonstrate the reasonableness of the expenses sought and avoid the practical concern that each billing cycle could result in a mini-trial, putting a substantial burden on the courts, all while honoring the clear public policy that advancement disputes must be resolved quickly to have any benefit? The issue becomes even more complex when the court finds that a director or officer is entitled to advancement for some, but not all, of the claims asserted in the underlying proceeding, so the issue is not always one of reasonableness but the more fundamental question of entitlement, as in the Court of Chancery's 2008 opinion in Zaman v. Amedeo Holdings Inc. finding that plaintiffs were entitled to advancement of expenses incurred in defending and prosecuting some, but not all claims.
In Fasciana v. Electronic Data Systems Corp., a 2003 opinion, then-Vice Chancellor Leo E. Strine Jr. ordered counsel for the party seeking advancement to provide an affidavit to certify in good faith that the expenses sought were reasonable. (See also Zaman, requiring certification of counsel that amounts sought were consistent with the opinion establishing entitlement.) Though commendable in its simplicity, at times this approach has not resolved the problem of monthly disputes over bills, or delays in payment. In an attempt to break the "logjam," in Duthie v. CorSolutions Medical Inc., a 2008 opinion, Vice Chancellor John W. Noble proposed a procedure that expanded on the certification of counsel:
"(1) Plaintiffs' counsel, if they have not already done so, shall certify in good faith that the fees and expenses for which advancement has been sought were incurred reasonably as a matter of sound professional judgment; (2) Defendants shall identify those fees which they assert fall outside the standard of Delaware law for advancement; their counsel shall certify their good-faith belief that the advancement of such fees is not appropriate; (3) the fees as to which there is no dispute shall be promptly paid; this includes those fees addressed above; and (4) the fees as to which any dispute remains shall be submitted to a special master."
The benefit of this approach is that the undisputed fees are (or should be) paid immediately, and the corporation cannot simply interpose a blanket objection to all fees to avoid the obligation — its counsel must identify the fees to which it objects and certify in good faith that the advancement of those fees is not appropriate. Noble later modified this process to impose on the corporation the costs of the special master if the objections turn out not to have been made in good faith in Fuhlendorf v. Isilon Systems Inc. Despite the merits of this approach, it also imposes an additional expense of a special master, which increases costs, regardless of who is obligated to pay them. Further, special masters are usually members of the corporate bar, which is known for its collegiality. Given that the special master is likely to know all of the counsel involved, asking him or her to make a finding that a contemporary made a bad-faith objection to an advancement request puts the special master in a very difficult position.
In a recent opinion, Vice Chancellor J. Travis Laster expanded the Duthie procedures further to streamline the process and impose a greater obligation on the Delaware counsel involved in the advancement action. In Danenberg v. Fitracks Inc., a March 5 opinion, Laster lauded the work done by special masters in advancement proceedings, but noted that, although special masters are not cheap, corporations nonetheless will "resist advancement vigorously before the special master, take advantage of the opportunity to raise objections before this court, and then still may pursue an appeal." Starting from the premise that Delaware counsel should be able to work in good faith to process advancement requests, the court imposed a detailed procedure for processing advancement claims, with a substantial focus on Delaware counsel.
In summary, the procedure involves the following steps:
1. By the 10th of every month, the plaintiff will submit his advancement demand for the previous month, including a detailed invoice with time entries and descriptions, along with a certification from the senior member of the Delaware bar that he or she personally reviewed the invoice, the expense falls within the scope of the plaintiff's advancement right and is reasonable pursuant to Rule 1.5(a) of the Delaware Rules of Professional Conduct.
2. By the 20th calendar day of the month, the defendant's counsel will respond to the advancement demand in writing. The response must identify each specific time entry or expense to which the defendant objects, explain the nature of the objection and cite any legal authority supporting the objection. Any objection not included in the response is deemed waived. The senior member of the Delaware bar representing the defendant must certify that he or she personally reviewed the advancement demand and, in his or her professional judgment, the disputed fees and expenses are not reasonable or otherwise fall outside the scope of the advancement right.
3. The defendant is required to pay the undisputed amount contemporaneously with the response, i.e., no later than the 20th calendar day of the month. If the defendant disputes more than 50 percent of the amount sought in any advancement demand, the defendant shall pay 50 percent of the total amount sought and plaintiffs counsel shall hold the amount exceeding the undisputed amount in its escrow account pending resolution of the dispute regarding such portion.
4. Plaintiffs counsel must reply in writing to the objections to advancement by the 25th of each month, supplying any additional information and legal authority.
5. Before the last calendar day of the month, the senior members of the Delaware bar representing each side will meet, in person, and confer regarding any disputed amounts. Any additional advancement that results from the meet-and-confer session will be paid with the next month's payment of undisputed amounts.
6. Not more frequently than quarterly, the plaintiff may file an application pursuant to Court of Chancery Rule 88 seeking a ruling on the disputed amounts. Briefing shall consist of a motion, an opposition filed within 15 days of the motion, and a reply filed within 10 days of the opposition. Neither party is permitted to raise any new arguments or authorities not previously raised with the other side in the applicable demand, response, reply or meet-and-confer. The court will determine if a hearing is warranted.
7. If the court grants an application in whole or part, then prejudgment interest is due on the adjudicated amount from the date of the applicable advancement demand. In addition, in parallel with the next advancement demand, the plaintiff may demand indemnification for the fees and expenses incurred in connection with the granted application, proportionate to the extent of success achieved. The parties shall address the indemnification demand in the same manner as the advancement demand. Except in connection with a successful application, petitioner Noam Danenberg shall not seek or receive advancement or indemnification for time spent preparing invoices and advancement demands, addressing responses or conferring regarding advancement requests.
What does this procedure do that is different from Duthie? First, and most obviously, it imposes a greater burden on the Delaware lawyers to resolve as many differences as they can. Second, it specifies that undisputed amounts must be paid by a certain date, and that in no event will plaintiffs counsel hold less than 50 percent of the amount sought in its escrow account, even if the defendant objects to the entire amount. This procedure avoids a corporation using a "slow pay" technique to impose economic burdens on plaintiffs counsel. Third, it avoids the expense of a special master, thereby putting the burden to resolve objections back onto the court, but only on a quarterly basis. Fourth, the process draws from the recently released "Guidelines to Help Lawyers Practicing in the Court of Chancery" to borrow the concept that disputes could be resolved much sooner if the parties made all of their arguments in the time before the dispute is brought to the court, so the court will not consider arguments not made in the objection, reply or meet-and-confer process.
Whether this process will prove to be successful in streamlining advancement requests will be proven only over time. Indeed, the premise of this article is not to say that the Danenberg approach is better than Duthie. The point is that balancing the competing interests under Delaware law in the processing of advancement requests is a difficult task, not subject to a ready solution. The procedures used currently by the various members of the court have benefits and risks for each side. Though corporations may avoid this dilemma by establishing an advancement processing procedure in their bylaws, as a general rule, advancement bylaws do not include such provisions. Therefore, directors and corporations engaged in a dispute over advancement should anticipate that there will be a procedure imposed upon them to resolve advancement disputes going forward if they cannot agree on a procedure themselves.