Chancery Court Expands on When Legal Fees Can Be Advanced
Advancement and indemnification rights provide directors and officers of Delaware corporations comfort when accepting positions that often lead to being named in litigation. However, once the interests of the executive and the company diverge, advancement rights can become a hotly contested issue. In dealing with advancement and indemnification claims, the Court of Chancery will analyze a company's bylaws and charter to determine to what extent that company has contracted with its executives to advance and indemnify legal fees. Many Delaware corporations, like Echo Therapeutics Inc. in the matter discussed herein, have bylaws and charters that allow for advancement and indemnification "to the full extent not prohibited under Delaware law." It is within that broad scope that decisions from the Court of Chancery, like the one authored in this case, guide practitioners in crafting arguments both for and against the advancement of legal fees.
In Mooney v. Echo Therapeutics (Del. Ch. May 28, 2015), the Court of Chancery faced a complicated set of facts surrounding Dr. Patrick Mooney's 2013 termination from Echo Therapeutics as its CEO and chairman of the Echo board of directors. Prior to Mooney's termination, the Financial Industry Regulatory Authority (FINRA) began an investigation into suspicious trading in Echo's stock. Shortly before Mooney's termination, Echo instigated an internal investigation into Mooney's alleged misconduct. Mooney was ultimately terminated by Echo on Sept. 27, 2013, for cause. Thereafter, Mooney filed a lawsuit against Echo in Pennsylvania asserting claims for breach of Mooney's employment agreement, violation of various wage and payment statutes, defamation and loss of consortium. Echo responded to this lawsuit by filing an answer, new matter and four counterclaims against Mooney. The counterclaims contained extensive allegations of misconduct by Mooney. Following Echo's filing of the counterclaims, Mooney demanded advancement of his legal fees. Echo sought to moot Mooney's advancement claims by amending the counterclaims to remove allegations of misconduct by Mooney. In an effort to vindicate his reputation, Mooney filed a second action against Echo in Pennsylvania alleging wrongful use of civil proceedings against Echo for pursuing the new matter and counterclaims in the first Pennsylvania action.
In August 2014, Mooney filed his complaint in the Court of Chancery seeking advancement for legal fees expended not only in defending against the Echo counterclaims, but also for fees incurred in prosecuting his actions against Echo as well as legal fees relating to the Echo internal investigation and the FINRA investigation. Vice Chancellor Donald F. Parsons Jr. considered each demand for advancement individually. First, the court considered Mooney's request for advancement regarding legal fees incurred as a result of the FINRA investigation. Echo disputed any obligation to advance fees regarding the investigations because Mooney was not a party nor was he threatened to be a party to the FINRA investigation. The court agreed with Echo, finding unpersuasive Mooney's argument that since Echo's submissions to FINRA cast a negative light upon Mooney he was compelled to inject himself into the process.
Next, the court considered Mooney's request for advancement relating to the internal investigation. Echo had advanced fees to Mooney relating to this investigation, but had refused to advance fees incurred after the investigation began but before Echo had filed counterclaims in the Pennsylvania action, amounting to $11,418. Despite Mooney's argument that the outstanding fees were incurred "in defense of accusations and termination allegedly for cause," the court noted that there is no precedent for advancement being granted for work done in anticipation of defending against a then-non-existent lawsuit. Turning to the Pennsylvania litigation, the court noted that Echo had paid most of Mooney's fees incurred in defending against Echo's initial new matter and counterclaims. Based on the record before it, the court was not able to determine whether the amount in dispute, approximately $34,000, was advanceable since Echo argued, among other things, that those fees related to work performed on Mooney's offensive claims. The court did state that even if Mooney incurred fees for work that was necessary to both advanceable and non-advanceable claims, Delaware law favored the advancement of the entirety of those fees as they would be necessary had only the advanceable claim existed.
The more substantial dispute involved Echo's amended new matter and counterclaims, in which Echo intentionally removed allegations of misconduct against Mooney to moot his advancement claims. Invoking Delaware precedent supporting such actions by defendants, Echo stated on the record that it was not pursuing any official-capacity claims against Mooney. Notwithstanding Echo's assertions, the court held that Echo's responses to interrogatories made it likely that the amended counterclaims would likely implicate Mooney's executive-capacity conduct. For instance, Echo averred that "Mooney frequently threatened Echo employees, particularly employees at the vice president level and above, with termination if they did not do what he wanted them to do." The court held that such an allegation necessarily implicated Mooney's role as CEO, since only as CEO could such threats carry any weight. Similarly, the court held that Mooney's fees in defense of the amended new matter were also advanceable as those affirmative defenses related to arguments that Mooney, among other things, wrongfully entered into agreements binding Echo. Again, the court found that such claims necessarily implicated Mooney's executive role.
The court was not persuaded that Mooney's fees incurred in prosecuting his claims in the second Pennsylvania litigation were advanceable. Mooney contended that he filed the second Pennsylvania action to vindicate his honesty and integrity. Despite Mooney's invocation of the term "defending" in relation to his prosecution of the second Pennsylvania litigation, the court noted Delaware precedent holding that prosecuting claims is only considered "defensive" for advancement purposes where the claims are compulsory counterclaims. In denying Mooney's claim for advancement, the court stated that "vindicating one's reputation may serve important personal objectives, but that does not mean that filing an offensive lawsuit qualifies as 'defending' within the meaning of 8 Del. C. Section 145."