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Chancery Finds Company Responsible for Advancing Costs of Defense to Its CEO in a Claim Brought by the Company

International Rail Partners LLC v. American Rail Partners, LLC, C.A. No. 2020-0177-PAF (Del. Ch. Nov. 24, 2020)

The Delaware Limited Liability Company Act (the “LLC Act”) allows a limited liability company (“LLC”) to provide for indemnification as to “any and all claims and demands whatsoever” against an LLC manager or officer, “[s]ubject to such standards and restrictions, if any, as are set forth in [the] limited liability company agreement.” 6 Del. C. § 18-108. The statute prescribes that the LLC agreement may indemnify any person to the fullest extent possible by contract. The only restrictions are those expressly set forth in the relevant LLC contract provisions. An LLC agreement is construed in accordance with Delaware law regarding contract interpretation.

In International Rail Partners LLC, the individual plaintiff (“Plaintiff”), an officer of the defendant LLC (“Defendant” or the “Company”), brought an action in the Court of Chancery to enforce his rights to advancement under the Company’s LLC agreement. The advancement action arose out of an underlying dispute between the Company and Plaintiff, in which the Company alleged that Plaintiff mismanaged the Company and enriched himself to the detriment of the Company. Based on those allegations, the Company brought an action in the Delaware Superior Court seeking damages against Plaintiff (the “Superior Court Action”). Defendant responded to Plaintiff’s advancement action by arguing that Plaintiff was not entitled to advancement because Plaintiff was defending the Superior Court Action against the Company itself. According to Defendant, the Company’s LLC agreement did not provide for advancement where the claims were brought by or on behalf of the Company against the covered person (which Defendant referred to as “first-party claims”). In reaching this conclusion, Defendant reasoned that the LLC agreement did not expressly address first-party claims and, therefore, no advancement for such claims was allowed—even though the terms of the agreement provided for advancement and indemnification for expenses “arising from any and all claims” against a covered person (as Defendant conceded Plaintiff to be).

The Court rejected Defendant’s arguments, however, and granted judgment on the pleadings to Plaintiff. The Court reasoned that “[i]f Defendant’s position is to be accepted, an LLC Agreement that uses the precise language of the statute to provide for indemnification and advancement to all of its members, managers, and other specified persons as to ‘any and all claims whatsoever’ does not mean what it says." The Court came to this conclusion despite Defendant’s reliance on Delaware case law relating to indemnification agreements in the bilateral commercial contract context. Those cases suggested that an indemnification provision in a bilateral commercial contract does not operate to shift fees in a claim between parties unless the contract explicitly addresses the issue. The Court noted that the leading Delaware case on this issue was TranSched Sys. Ltd. v. Versyss Transit Solutions, LLC, 2012 WL 1415466 (Del. Super. Mar. 29, 2012). The Court reasoned, however, that TranSched was inapplicable in the LLC indemnification context (under 6 Del. C. §18-108) because TranSched interpreted a standard indemnity clause in a bilateral commercial purchase agreement and was decided in the context of an arms-length transaction between two commercial entities. The TranSched Court reasoned that, if it interpreted such a standard indemnity agreement as shifting attorneys’ fees in a claim between the parties, the American Rule in Delaware would be eviscerated.

As such, the Court found that TranSched did not create a presumption that advancement for first-party claims was disallowed in the Section 18-108 context. Instead, the Court found that LLC indemnification agreements must expressly preclude first-party claims—if the parties wished to do so—reasoning that “[g]iven the statutory framework, the broad language of the LLC Agreement’s indemnification provision, and the strong public policy in favor of indemnification and advancement, … I decline to elevate an interpretive presumption applied to commercial contracts above the strong public policy of advancement and indemnification, particularly in light of the ‘capacious and generous standard’ articulated in the American Rail LLC Agreement.” The Court accordingly ordered the Company to the advance the Plaintiff CEO’s reasonable attorneys’ fees and expenses in defending against the Superior Court Action.

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