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holding that the party opposing the motion "has not met its burden of proof to show that indemnification is not available"
Summary of this case from Galante v. Queens Borough Pub. LibraryOpinion
01 Civ.6434 (GEL).
January 15, 2002
OPINION AND ORDER
In this action brought by Happy Kids, Inc., against Andrew and Roberta Glasgow for fraud and breach of fiduciary duty, defendant Andrew Glasgow moves for an order directing the plaintiff to advance him his attorneys' fees and other expenses of litigation pursuant to an indemnification agreement between the parties as well as the New York Business Corporation Law ("BCL").
It is undisputed that Glasgow sold his children's clothing business to plaintiff Happy Kids, also in the children's clothing business, pursuant to an agreement by which Glasgow agreed to become an officer and director of Happy Kids and continue to operate his former business as a unit within the plaintiffs corporate framework. As part of that agreement, Glasgow and Happy Kids agreed that Glasgow would be indemnified:
to the fullest extent permitted by law if Indemnitee was or is or becomes a party to . . . any threatened, pending or completed action [or] suit . . . by reason of (or arising in part out of) any event or occurrence related to the fact that Indemnitee is or was a director, officer, employee, agent or fiduciary of the Company, or any subsidiary of the Company . . . against any and all expenses (including attorneys' fees and all other costs . . . incurred in connection with . . . defending . . . or preparing to defend . . . any such action [or] suit . . .)
(Def's Br. Ex. A at 1-2.) The parties now dispute the meaning, effect and scope of this indemnity.
Happy Kids has sued Glasgow, charging essentially that he made fraudulent misrepresentations about the value of his business before the closing of the sale, mismanaged the business and engaged in deceptive accounting practices after he began to work for Happy Kids. Glasgow's answer denies these allegations and he has moved to dismiss the fraud claim. Glasgow now argues that he is entitled under the indemnity agreement to payment of any legal fees he incurs in defending the fiduciary duty claims, and seeks an order directing advance payment.
Defense counsel conceded during oral argument on November 29, 2001, that Glasgow is not entitled to payment of attorneys' fees or indemnification in connection with the fraud claims. (11/29/01 Tr. at 30.)
1. Indemnification
Although the question of advancement of attorney's fees starts with interpretation of the New York statute, it ends as one of contract interpretation. New York law provides for the indemnification of officers and directors for litigation expenses under certain circumstances. See BCL §§ 722, 723. Glasgow does not contend that such indemnification has been triggered here. However, New York also provides that the statutory indemnification procedures are not exclusive, and authorizes a corporation to agree to indemnify officers and directors. The only limitation on this right is that a corporation may not indemnify "if a judgment or other final adjudication adverse to the director or officer establishes that his acts were committed in bad faith or were the result of active and deliberate dishonesty, . . . or that he personally gained in fact a financial profit or other advantage to which he was not legally entitled." Id. § 721. Corporations are also authorized to pay such expenses in advance, id. § 723(c), and a court is authorized to order payments during the pendency of the litigation "if the court shall find that the defendant has by his pleadings . . . raised genuine issues of fact or law," id. § 724(c). Courts have utilized § 724(c) to direct the advance payment of fees where the indemnification was provided for by a corporate by-law or contract, Sequa v. Gelmin, 828 F. Supp. 203, 206 (S.D.N.Y. 1993), Sierra Rutile Ltd. v. Katz, 1997 WL 431119, at *1 (S.D.N.Y. July 31, 1997), as well as when no corporate indemnification agreement existed, Booth Oil Site Admin. Group v. Safety-Kleen Corp., 137 F. Supp.2d 228, 236 (W.D.N.Y. 2000). However, § 725(b) of the BCL then directs the Court's attention to any existing indemnification agreement between the parties, stating:
no indemnification, advancement or allowance shall be made under this article . . . where . . . (1) the indemnification would be inconsistent with the law . . . (2) . . . the indemnification would be inconsistent with a provision of the certificate of incorporation, a by-law . . . an agreement or other proper corporate action, in effect at the time of the accrual of he alleged cause of action . . . which prohibits or otherwise limits indemnification . . .
Thus, the New York BCL allows the Court to order the advance of reasonable litigation expenses to Glasgow, as a director of Happy Kids, to the extent consistent with both the statute and Glasgow's indemnification agreement with Happy Kids, if Glasgow, by his pleadings, has raised genuine issues of fact or law. In Glasgow's answer to Plaintiffs complaint, he denies all allegations that he breached his fiduciary duty to Happy Kids. Although Glasgow moves to dismiss only the fraud allegations, and not the breach of fiduciary duty claims, Glasgow's answers to the pleadings suffice to raise genuine issues of fact for purposes of the BCL. See Sequa Corp, 828 F. Supp. at 207. As stated above, indemnification is prohibited by the statute only once a final adjudication of bad faith or personal gain by the director is finally obtained. Thus, at this stage in the proceedings, the only remaining question is whether an advance of attorneys' fees is consistent with Glasgow's indemnification agreement with Happy Kids.
In this case, the action against Glasgow is brought not by an outside party to challenge Glasgow's actions on behalf of the corporation, but by the corporation itself charging misconduct at the corporation's expense. New York law recognizes that this situation is unusual. As the Court of Appeals ruled in Hooper Associates. Ltd. v. AGS Computers. Inc., 74 N.Y.2d 487, 491 (2d Cir. 1989), promises to indemnify "must be strictly construed." Because the general American rule requires parties to bear their own litigation expenses, a promise by one party to indemnify the other for litigation experiences between themselves is exceptional, and thus a court "should not infer a party's intention to waive the benefit of the rule unless the intention to do so is unmistakably clear from the language of the promise." Id. at 492. Hooper did not arise in the context of an officer's or director's indemnification agreement, but in the case of a commercial contract for the sale of computer equipment. Nevertheless, the fact remains that the Court in that case declined to order indemnification pursuant to broad contractual language requiring one party to indemnify the other for "any and all claims, damages, liabilities, costs and expenses, including counsel fees, arising out of' breach of warranty by the seller, infringement of intellectual property rights, or the like, finding that the language did not unequivocally apply to litigation between the parties. Hooper thus establishes that under New York law, contracts of indemnity must be construed strictly, with an eye to whether the agreement unmistakably provides for indemnification of legal fees in litigation between the parties.
On the other hand, neither the Hooper holding nor anything in the BCLprohibits such indemnification, and courts applying New York law have awarded such indemnification. See, e.g. Sequa Corp., 828 F. Supp. 203;Sierra Rutile Ltd., 1997 WL 431119.
In this case, the indemnification agreement is made in connection with an officer's employment contract, and is worded particularly broadly. The agreement's preamble specifies that it is the intent of Happy Kids "to provide for the indemnification and advancing of expenses to [Glasgow] to the maximum extent permitted by law." (Def's Letter Br. Ex. A at 1.) It provides that Happy Kids:
shall indemnify [Glasgow] to the fullest extent permitted by law if [he] . . . becomes a party to . . . any threatened, pending or completed action . . . arising in part out of . . . any event or occurrence related to the fact that [he] is or was a director, officer, employee, agent or fiduciary of [Happy Kids] . . ., or by reason of any action or inaction on [his] part . . . while serving in such capacity.Id. at § 1(a). Advance payment of expenses is specifically provided for in sections 2(a) and 13. The agreement repeatedly emphasizes that Happy Kids agrees to indemnify Glasgow "to the fullest extent permitted by law, notwithstanding that such indemnification is not specifically authorized by other provisions of this Agreement" or by the corporate bylaws, certificate of incorporation or statute, and that the agreement goes beyond and is in addition to what is required by statute. Id. at §§ 3(a), (b). Finally, the Glasgow agreement places the burden of proof on the company to show that Glasgow is not entitled to indemnification under the agreement. Id. at § 2(c).
The literal import of these provisions clearly covers litigation between the parties, since indemnification in a case such as this one is not prohibited by law. Moreover, this conclusion is not, as a similar conclusion would have been in Hooper, simply the literal implication of one of a narrow but perhaps carelessly-worded list of types of actions indemnified. Here, rather, the parties repeatedly emphasize their intention to cover as broad a range of lawsuits as the law will permit.
Broad as it is, however, the agreement is not unlimited in its reach. Quite significantly, the agreement lists certain exceptions to the indemnification right. In addition to excepting liability for those actions for which directors may not legally be relieved of liability, and liability under § 16(b) of the Securities Exchange Act of 1934, the agreement specifically excepts one category of litigation between the parties. In § 8(b) of the agreement, the parties provide that there is no right to indemnity or advance expenses for proceedings initiated by Glasgow, except for proceedings to enforce a right of indemnification. This limitation reinforces the conclusion that the parties did not impliedly except litigation between themselves from the indemnification provisions. If certain actions brought by Glasgow against Happy Kids had to be expressly excluded from the indemnity, and other such actions then restored to coverage by being excepted from the exclusion, it cannot be maintained that the parties implicitly assumed that any litigation between themselves was by its nature outside the scope of the very broad language of the agreement.
There is no corresponding exclusion, moreover, for actions initiated by Happy Kids. If the agreement were implicitly intended to apply only to actions brought by third parties, there would be no need to exclude actions brought by the director, and if it was felt necessary to exclude actions by the director (including actions by the director against the company), there is no explanation why it is somehow implicit that the indemnity does not apply to actions brought by the company against the director.
The agreement in this case, thus, meets the test of Hooper. The all-encompassing nature of the indemnity provided, the clear expressions of intent to reach to the maximum lawful extent of liability, and the express exception of certain categories of litigation between the parties compel the conclusion that the parties unmistakably intended an indemnity for other forms of litigation between them. To hold otherwise would be to construe Hooper to mean that no contract can be found to require indemnification for actions between the parties unless it expresslyincludes such actions — something the Hooper court nowhere requires. Accordingly, Happy Kids has not met its burden of proof to show that indemnification is not available to Glasgow under the indemnification agreement.
Happy Kids' other arguments can be disposed of more quickly. Happy Kids, again relying on BCL § 725(b), maintains that indemnification of Glasgow would be inconsistent with the company's by-laws. But as with its argument that the indemnification agreement does not allow for indemnification, Happy Kids points to nothing in the by-laws precludes such indemnification. Its argument establishes simply that the by-laws do not expressly provide indemnification, not that they prohibit it. The by-laws permit the company to enter an indemnification agreement broader than their own express terms, and that's just what the agreement with Glasgow, on its face, does. (Def.'s Letter Br. Ex. A at § 3(a).)
That the complaint in this case accuses Glasgow of behavior that, if proved, would preclude indemnification does not prevent Happy Kids from being required to advance fees. Courts have routinely ordered indemnification where a director is charged with intentional misconduct.See Sequa Corp., 828 F. Supp. at 206; Booth Oil, 137 F. Supp.2d at 236. As Judge Keenan stated in Sierra Rutile, "If the director or officer satisfies the BCL's requirements, the Court may order their corporation to advance litigation expenses, notwithstanding the corporation's allegations that the director or officer engaged in wrongdoing against the corporation." 1997 WL 431119 at *1. Advance payment of fees is authorized if the defendant has "raised genuine issues of fact of law," BCL § 724(c), as defendant here has clearly done.
2. Apportionment
Happy Kids' obligation to fund Glasgow's reasonable litigation fees covers only the reasonable expenses and attorney's fees incurred in defending the fiduciary duty potion of this suit. Given the considerable overlap of issues and legal work between the fiduciary duty and fraud in the inducement claims, it is not practicable to segregate strictly the litigation expenses applicable to the two causes of action. While some expenses (for example, those attributable to prosecuting the motion to dismiss the fraud claims) will clearly be outside the indemnity, many litigation expenses will not be so clearly identifiable with one or the other set of issues. For example, if the fraud claims survive defendants' motion, and Glasgow is deposed by plaintiff it would be absurd to parse the questions asked at the deposition in an effort to allocate the cost of defending the deposition as between the claims. Moreover, subsidiary litigation over Glasgow's legal bills while the case proceeds would not only be distracting and wasteful, but would threaten disclosure of confidential attorney-client information. Some simpler method of apportioning the advance is accordingly required.
Therefore, counsel for Glasgow are directed to establish separate billing matters for the fraud claim, the breach of fiduciary duty claims, and general litigation activity not specifically attributable to either claim. Glasgow will be entitled to advance payment of no fees in the first category, of all fees in the second category, and — because plaintiffs fiduciary duty claims represent roughly one-half of its complaint — one-half of expenses in the third. Any fees advanced under § 724(c) are strictly a preliminary award, and are subject to modification under § 725(a) upon the conclusion of the litigation. If Glasgow is found liable for misconduct that would defeat indemnification, he will be required to repay the forwarded fees to Happy Kids as provided in BCL § 725(a). If he prevails on the fiduciary duty claims, Happy Kids will be entitled to seek a more precise accounting, at which Glasgow will have the burden to demonstrate the appropriateness of all fees advanced, including whether this rough apportionment ratio was appropriate in light of the issues actually litigated, and will either be required to refund any excess, or to demand any short-fall. Booth Oil, 137 F. Supp. at 238.
of course, if the fraud claims are dismissed, the matter of allocation will be much simplified, and Glasgow will be free to apply to the Court for a modification of this order, since under those circumstances, all future litigation expenses would be required to be advanced.
3. Bond
Happy Kids asserts that Glasgow should be required to post a bond against the possibility that he is ultimately found liable for misconduct of a sort that would preclude indemnification But this request is expressly precluded by the agreement between the parties. Under § 1(b) of the agreement, Glasgow is indeed obliged to repay any advances should it eventually be determined that indemnification is prohibited by law. (Def's Letter Br. Ex. A at 2.) However, the same section of the agreement further states that "Indemnitee's obligation to reimburse the Company for any Expense Advance shall be unsecured and no interest shall be charged thereon." Id. Happy Kids thus explicitly bargained away any claim to the bond it asks for.
Conclusion
Accordingly, Defendant's motion for advancement of litigation expenses incurred in defense of the instant action is GRANTED to the extent and on the terms outhned in this opinion.
SO ORDERED: