Opinion
Civil Action No. 20048.
Date Submitted: July 28, 2003.
Date Decided: August 1, 2003.
Kenneth J. Nachbar, Esquire, MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; Jonathan Rosenberg, Esquire and Daniel L. Cantor, Esquire, O'MELVENY MYERS LLP, New York, New York, Attorneys for Plaintiff Michael A. Weinstock.
Norman M. Monhait, Esquire, ROSENTHAL MONHAIT GROSS GODDESS, P.A., Wilmington, Delaware; Kenneth A. Zitter, Esquire, LAW OFFICES OF KENNETH A. ZITTER, New York, New York, Attorneys for Plaintiff Andrew J. Herenstein.
Anne C. Foster, Esquire and Steven L. Brinker, Esquire, RICHARDS, LAYTON FINGER, Wilmington, Delaware; Thomas G. Rafferty, Esquire and Kenneth Lee, Esquire, CRAVATH, SWAINE MOORE, New York, New York, Attorneys for Defendants.
MEMORANDUM OPINION.
In this case, two former managers of two investment funds operated by a large investment bank seek advancement of litigation expenses for lawsuits brought against them by the investment bank. The investment bank alleges that the managers lost their right to advancement under the respective operating agreements of the funds' general partner and investment manager when they severed their employment with the investment bank.
This opinion resolves the former managers' motion for partial summary judgment. Herein, I conclude that, under the undisputed facts, the former managers are entitled to advancement. When read contextually, the relevant provisions of the operating agreements do not make the right to advancement depend on current service in a covered capacity. Instead, the key inquiry is whether the party seeking advancement has been sued by reason of the fact that he did serve or is now serving in a covered capacity. Because the suits against the former managers meet this basic test, they are entitled to advancement under each of the relevant operating agreements, as well as for reasons unique to each agreement, which are set forth in this opinion.
I. Factual Background
This is an action for advancement brought by plaintiffs Michael A. Weinstock and Andrew J. Herenstein. They seek advancement for litigation expenses they are incurring in defending two lawsuits brought by entities controlled by their former employer, Lazard Frères Co. LLC ("Lazard").
Plaintiff Weinstock was a Lazard Managing Director. Plaintiff Herenstein was a Lazard Director. In those capacities, the plaintiffs were assigned to be the co-portfolio managers of two Lazard investment funds, Lazard Debt Recovery Fund, L.P. (the "U.S. Fund") and Lazard Debt Recovery Fund, Ltd. (the "Offshore Fund"). In the offering circular used to solicit investments in the Funds, Lazard identified the plaintiffs as Directors of the Investment Manager.
Lazard controlled both Funds through defendant Lazard Debt Recovery GP, LLC, which was the Funds' "General Partner," and which in turn managed the Funds' investment and trading activities through Lazard Debt Recovery Management LLC (the "Investment Manager"). Both the General Partner and the Investment Manager were wholly-owned subsidiaries of Lazard.
According to the defendants, the plaintiffs severed their relations with the Funds very abruptly, by terminating their employment on February 28, 2002 without prior notice. At the time the plaintiffs announced their resignation, they allegedly put pressure on Lazard to transfer the assets of the Funds to a new distressed debt fund that the plaintiffs intended to form at a Lazard competitor, Quadrangle. Because of the unique nature of investments in distressed debt, the defendants allege that the resignation of the plaintiffs without notice left Lazard in a difficult predicament. Lacking the plaintiffs' expertise in managing the assets of the Funds, Lazard risked exposing investors to losses unless it either immediately retained replacements (who are not readily and instantly available), transferred the assets to the new Quadrangle fund, or closed the Funds altogether.
In response to the plaintiffs' actions, two lawsuits were filed against the plaintiffs. These are the suits for which the plaintiffs seek advancement. The first the Delaware Action was brought by Lazard individually and derivatively on behalf of the U.S. Fund in this court. Plaintiffs Weinstock and Herenstein were both named as defendants in the Delaware Action. That Action alleges causes of action for breach of fiduciary duty, misrepresentation, and breach of contract. It is undisputed that all of the allegations relate to the plaintiffs' positions as co-portfolio managers of the U.S. Fund. In the complaint in the Delaware Action, Lazard alleges that the plaintiffs were "Directors" of the Investment Manager.
Lazard filed the second action in Bermuda solely against Weinstock. The Bermuda Action alleges a single claim for breach of fiduciary duty and relates to Weinstock's position as co-portfolio manager of the Offshore Fund.
Plaintiffs Weinstock and Herenstein sought advancement for their expenses in these Actions from both the General Partner and the Investment Manager and signed the required undertaking to repay the funds in the event ultimate indemnification was unavailable to them.
Neither the General Partner nor the Investment Manager agreed to advance the requested litigation expenses. The plaintiffs then filed this action under 8 Del. C. § 145.
II. The Central Issues Raised by the Plaintiffs' Motion for Partial Summary Judgment
The plaintiffs seek partial summary judgment in their favor as to the issue of whether they are entitled to advancement from the General Partner and the Investment Manager for their expenses in defending the Delaware and Bermuda Actions. The plaintiffs have not sought summary judgment on the amount of advancement they are currently owed, deferring that issue for later determination.
The procedural standard to be applied to the plaintiffs' motion is familiar. To prevail, the plaintiffs must demonstrate that there are no genuine issues of material fact and that they are entitled to judgment as a matter of law. As in most advancement disputes, summary judgment practice is an efficient and appropriate method to decide this case, as the relevant question turns on the application of the terms of the corporate instruments setting forth the purported right to advancement and the pleadings in the proceedings for which advancement is sought. Here, the defendants have admitted the critical facts asserted by the plaintiffs and the only issues are whether, under these undisputed facts, the plaintiffs have a right to advancement under the terms of the operating agreements of (1) the General Partner and (2) the Investment Manager.
See Del. Ct. Ch. R. 56(c); Gilbert v. El Paso, 575 A.2d 1131, 1142 (Del. 1990).
See Reddy v. Elec. Data Sys. Corp, 2002 WL 1358761, at *3 (Del. Ch. June 18, 2002), aff'd, 820 A.2d 371 (Del. 2003).
The defendants have asserted an unclean hands defense arguing that the plaintiffs have sought legal fees incurred in connection with planning their departure from the Funds, rather than solely for defending the Delaware and Bermuda Actions. The defendants assert that this must be so because the plaintiffs' advancement requests are so large in comparison to the work that had to be done in the Delaware and Bermuda actions. For this alleged overreaching, the plaintiffs, according to the defendants, should face an absolute bar to any advancement award.
This argument is unconvincing. If the plaintiffs (i) in fact sought advancement for fees that are not properly subject to advancement and (ii) there was no good faith basis for the plaintiffs to assert that those fees were subject to advancement, then some form of relief might be due to the defendants under the bad faith exception to the American Rule or Court of Chancery Rule 11. Relief of that kind would be proportionate to whatever wrongdoing that the defendants believe has occurred and may be sought at a later time upon the development of a supportive factual record. Barring any advancement award to the plaintiffs at all would be overkill and inequitable and therefore in tension with the equitable purpose of the unclean hands doctrine.
The defendants have also argued that plaintiff Weinstock's letters seeking advancement did not use the appropriate nomenclature or were misaddressed. This argument does not suffice to defeat any claim to advancement that otherwise exists as a matter of contract. At the latest, the General Partner and the Investment Manager were aware of Weinstock's demand as of the time of the filing of the complaint in this action. In reality, they were both aware before then because the letters were sufficiently clear and received by the manager who took over from the plaintiffs in managing the General Partner and the Investment Manager, a person who should have understood (and I am sure, did understand) their clear import. In any event, to be responsive to the defendants' concern, plaintiff Weinstock should clarify in writing that his undertaking was directed to both the General Partner and the Investment Manager as a condition precedent to any award of judgment.
Both issues turn on whether the plaintiffs' termination of their employment by Lazard and of their service to the Funds disentitles them from advancement. According to the defendants, the operating agreements of both the General Partner and the Investment Manager limit advancement to persons currently serving in specified official capacities. Because the plaintiffs are not currently serving in these capacities, the defendants argue that they are not entitled to advancement.
With that basic dispute in mind, I turn first to the question of whether the plaintiffs are entitled to advancement under the operating agreement of the General Partner.
III. Legal Analysis
A. Do the Plaintiffs Have a Right to Advancement from the General Partner?
The pertinent provision of the General Partner's LLC Agreement that addresses advancement and indemnification rights states:
Section 2.06. Indemnification.
(a) Each indemnified Party shall, in accordance with this Section 2.06, be indemnified and held harmless by the Company from and against any and all losses, claims, damages, liabilities, expenses (including legal and other professional fees and disbursements), judgments, fines, settlements, and other amounts (collectively, the "Indemnification Obligations") arising from any and all claims, demands, actions, suits or proceedings (whether civil, criminal, administrative or investigative), actual or threatened, in which such Indemnified Party may be involved, as a party or otherwise, by reason of such person "s service to or on behalf of or management of the affairs of the Company, or rendering of advice or consultation with respect thereto, or which relate to the Company, its properties, business or affairs, whether or not the Indemnified Party continues to be such at the time any such Indemnification Obligation is paid or incurred, provided that such Indemnification Obligation resulted from a mistake of judgment, or from action or inaction of such Indemnified Party that did not constitute gross negligence, willful misconduct or bad faith. The Company shall also indemnify and hold harmless an Indemnified Party from and against any Indemnification Obligation suffered or sustained by such Indemnified Party by reason of any action or inaction of any employee, broker or other agent of such Indemnified Party; provided, however, that such employee, broker or agent was selected, engaged or retained by such Indemnified Party with reasonable care. The termination of a proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere, or its equivalent, shall not, of itself create a presumption that such Indemnification Obligation resulted from the negligence of such Indemnification Party. Expenses (including legal and other professional fees and disbursements) incurred in any proceeding will be paid by the Company in advance of the final disposition of such proceeding upon receipt of an undertaking by or on behalf of such Indemnified Party to repay such amount if it shall ultimately be determined that such Indemnified Party is not entitled to be indemnified by the Company as authorized hereunder.
(b) The indemnification provided by this Section 2.06 shall not be deemed to be exclusive of any other rights to which each Indemnified Party may be entitled under any agreement, or as a matter of law, or otherwise, both as to action in such Indemnified Party's official capacity and to action in another capacity, and shall continue as to such Indemnified Party who has ceased to have an official capacity for acts or omissions during such official capacity or otherwise when acting at the request of the Managing Member and shall inure to the benefit of the heirs, successors and administrators of such Indemnified Party.
General Partner LLC Agreement, ¶ 2.06(a)-(b) (emphasis added).
The defendants do not dispute that the plaintiffs are "Indemnified Parties" under this provision. By its plain terms, the General Partner's LLC Agreement defines "Indemnified Parties" as "Member[s] or Affiliate[s]." "Affiliates" are the "Managing Member and any members, officers, employees or other agents or advisers of the Managing Members or the [General Partner]." The Managing Member is Lazard. The plaintiffs were Lazard employees and therefore Affiliates.
Id. § 2.05(a).
Id. § 2.04.
The defendants also do not dispute that the Delaware and Bermuda Actions are proceedings as defined in the first sentence of § 2.06(a), and as referenced in the last sentence of § 2.06(a).
The defendants argue, however, that the plaintiffs as former, rather than current Affiliates have no right to advancement. They base this argument on the fact that § 2.06(b) states that the "indemnification" it provides "shall continue as to such Indemnified Party who has ceased to have an official capacity for acts or omissions during such official capacity or otherwise when acting at the request of the Managing Member . . . Because this grant of continued coverage only refers to the right to "indemnification provided by this Section 2.06," the defendants argue that § 2.06(b) does not provide former Affiliates with any right to the supposedly wholly distinct right of advancement.
Id. § 2.06(b).
I agree with the plaintiffs, however, that the defendants' reading cannot withstand close scrutiny. The entirety of § 2.06 addresses indemnification broadly and treats the right to receive payments of expenses in advance as a subsidiary component. As "Indemnified Parties" under the General Partner's LLC Agreement, the plaintiffs were entitled to receive all the indemnification-related rights set forth in § 2.06 regardless of whether they had ceased to serve in an official capacity. This is the clear intention of § 2.06, when read sensibly and completely. For example, the final sentence of § 2.06(a), which addresses advancement, clearly refers back to the first sentence of that subsection, which deals with ultimate indemnification. Thus, the final sentence of § 2.06(a) provides a right to advancement to "such Indemnified Part[ies]" as defined by the first sentence in "such proceeding[s]" as are also defined in the first sentence. A proceeding is expressly defined as one in which an "Indemnified Party may be involved
by reason of such person's service in a covered official capacity "whether or not the Indemnified Party continues to be such at the time any such Indemnification Obligation is paid or incurred . . ." Therefore, the right to receive expenses in advance (set forth in the last sentence of § 2.06(a)) is a subsidiary element of the right to ultimate indemnification (set forth in the first sentence of § 2.06(a)) and is conditioned on the filing of an undertaking to repay the advance if the conditions for ultimate indemnification set forth in the first sentence of § 2.06(a) are not met. For all these reasons, I find that § 2.06(a) does not grant advancement rights solely to Indemnified Parties who are currently serving in an official capacity, but instead to all Indemnified Parties facing proceedings as defined in the first sentence of § 2.06(a).
Id. § 2.06(a).
In a previous decision, this court reached a similar conclusion and held that the term indemnification in a certificate of incorporation had to be read to encompass the subsidiary concept of advancement because that was the evident and sensible intent of the drafters. The same reasoning applies with full force here.
In Greco v. Columbia/HCA Healthcare Corp., the defendants argued that the company's certificate of incorporation permitted recovery of "fees on fees" only for suits to enforce indemnification, not advancement, rights. The defendants based their argument on the following language which appeared in Subpart C of the company's certificate of incorporation:
Such person's costs and expenses incurred in connection with successfully establishing his or her right to indemnification, in whole or in part, in any such action shall also be indemnified by the Corporation.1999 WL 1261446 at *7 (Del.Ch. Feb. 12, 1999). This court rejected defendant's narrow construction of "indemnification", finding
that the term "indemnification" could refer to both "indemnification" and "advancement" in the certificate where that would make sense and be linguistically economical.
Id. at *13; cf Nakahara v. NS 1991 Am. Trust, 739 A.2d 770, 779 n. 52 (Del.Ch. 1998) ("Although indemnification and advancement are distinct rights, they are related concepts that are commonly addressed in neighboring statutory provisions." (emphasis omitted)).
The terms of § 2.06(b) contribute to my decision that § 2.06 does not make the distinction for which the defendants contend. In that subsection, the drafters of the operating agreement took care to recite the continued entitlement of Indemnified Parties to the full range of indemnification provided by § 2.06 rights that clearly included the subsidiary component of advancement. Although the defendants argue that this repetition of some of the language of the first sentence of § 2.06(a) must be read as an indication that § 2.06(b)'s reference to the "indemnification provided by this Section 2.06" means the right to ultimate indemnification only and not to the right to advancement of expenses, that argument is unconvincing. The first sentence of § 2.06(a) already provides such a guarantee of ultimate indemnification for Indemnified Parties who left service. The better understanding of § 2.06(b), therefore, is that the drafters wanted to ensure that departure from current service did not deprive an Indemnified Party facing a covered proceeding from any of the rights set forth in § 2.06, including the right to advancement in the last sentence of § 2.06(a) and the right to benefit from § 2.06's terms to the "fullest extent permitted by law, " as set forth in § 2.06(d).
Thus, I conclude that the plaintiffs are entitled to advancement from the General Partner for the Delaware and Bermuda Actions.
B. Are the Plaintiffs Entitled to Advancement from the Investment Manager?
The next question is whether the plaintiffs also are entitled to advancement from the Investment Manager under ¶ 18 of its LLC Agreement, which states:
18. Indemnification. To the full extent permitted by law, the LLC shall (a) indemnify any person or such person's heirs, distributees, next of kin, successors, appointees, executors, administrators, legal representatives or assigns who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative by reason of the fact that such person is or was a member, Managing Member, director, officer, employee or agent of the LLC or is or was serving at the request of the LLC or its members as a member, Managing Member, director, officer, employee or agent of another corporation, limited liability company, partnership, joint venture, trust or other enterprise, domestic or foreign, against expenses, attorneys' fees, court costs, judgments, fines, amounts paid in settlement and other losses actually and reasonably incurred by such person in connection with such action, suit or proceeding and (b) advance expenses incurred by a member, Managing Member, officer or director in defending such civil or criminal action, suit or proceeding to the full extent authorized or permitted by the laws of the State of Delaware. A Managing Member shall have no personal liability to the LLC or its members for monetary damages for breach of fiduciary duty as a Managing Member; provided, however, that the foregoing provision shall not eliminate the liability of a Managing Member for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law or for any transaction from which the Managing Member derived an improper personal benefit.
Investment Manager LLC Agreement, ¶ 18 (emphasis added).
The critical language in the paragraph is that which deals with the class of persons eligible for ultimate indemnification in ¶ 18(a) and that which deals with the class of persons eligible for advancement in ¶ 18(b).
The first class — defined in ¶ 18(a) — is comprised of any person
who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative by reason of the fact that such person is or was a member, Managing Member, director, officer, employee or agent of the LLC or is or was serving at the request of the LLC or its members as a member, Managing Member, director, officer, employee or agent of another corporation, limited liability company, partnership, joint venture, trust or other enterprise, domestic or foreign . . .
Id. ¶ 18(a).
The second class defined in ¶ 18(b) is narrower and encompasses only "member[s], Managing Member[s], officer[s] or director[s]" who are "defending [a] civil or criminal action, suit or proceeding."
Id. ¶ 18(b).
There is no dispute that the plaintiffs were directors of the Investment Manager and are being sued in proceedings as defined in ¶ 18(a). The only dispute is whether as former directors sued in covered proceedings, they are entitled to advancement under ¶ 18(b).
Because ¶ 18(a) does not create a broad definition of persons eligible for ultimate indemnification (such as the term "Indemnified Party" in the General Partner operating agreement) that is carried forward into ¶ 18(b), the defendants argue that the class of persons eligible for advancement under ¶ 18(b) is as set forth solely in that subparagraph of ¶ 18. By its own terms, ¶ 18(b) does not grant advancement rights except to a "member, Managing Member, officer or director" — that is, someone serving at the time when advancement is sought. Conspicuous by its absence, say the defendants, is language granting advancement to someone who "is or was" serving in those capacities. Thus, it must be presumed that this omission is intentional and that advancement is not owed to former members, Managing Members, officers, and directors.
The plaintiffs dispute this interpretation and argue that subparagraph ¶ 18(b) must be read in concert with ¶ 18(a). In that vein, they note that by its plain terms, subparagraph ¶ 18(b) refers back to ¶ 18(a). It does so by referring to the advancement rights of members, Managing Members, officers, and directors in "defending such . . . proceeding[s]" — an obvious linkage back to the proceedings defined in ¶ 18(a). When the proper relationship of the two subparagraphs is considered and their entire language taken into account, it is apparent, say the plaintiffs, that former directors like themselves are entitled to advancement.
Id. (emphasis added).
In my view, the plaintiffs have the better of the argument. If the defendants' interpretation of the drafters' intentions were correct, ¶ 18(b) should have read "expenses incurred by a person who is a member, Managing Member, officer or director in defending such . . . proceeding." The absence of the words "is or was" from ¶ 18(b) is best explained by the drafters' belief that the inclusion of those words would have been redundant in view of the obvious relation of ¶ 18(b) to ¶ 18(a) and the clear intention of the drafters of ¶ 18 not to make any of the rights provided in that paragraph dependent on current service. In that regard, it is important that ¶ 18(b) covers a director who faces a "proceeding" as defined in ¶ 18(a), and that the definition of proceeding in ¶ 18(a) means a suit brought "by reason of the fact that rail person is or was" serving in a covered capacity, such as a director. Therefore, the best reading of ¶ 18(b) is that it provides an advancement right to former directors facing a proceeding defined in ¶ 18(a).
In my view, another factor supports this reading. According to the defendants' interpretation of ¶ 18(b), a "member, Managing Member, officer or director" could die in office while defending a "proceeding" defined in ¶ 18(a). Despite the grant of indemnification rights to the survivors and successors of indemnified parties, the widower of a deceased director facing a proceeding covered by ¶ 18(b) would find that his wife's estate now had to bear the up-front costs of defending the action. This is a strange result to be implemented solely by the absence of the phrase "is or was" from ¶ 18(b).
This is not to say that the language of ¶ 18(b) is without independent meaning. The clear import of the language of ¶ 18(b), however, is only to narrow the list of permissible capacities eligible for advancement to a smaller number from that eligible for ultimate advancement under ¶ 18(a). That clear intention, however, is not accompanied by the further intention to deny advancement to former "members, Managing Members, officers or directors." For the reasons I have outlined, that additional intention does not emerge from the text of ¶ 18(b) when read in the full context of ¶ 18, as it must be, and could produce what, at least at first blush, appears to be an absurd result in the event of the death of a member, Managing Member, officer, or director entitled to advancement.
In view of these factors, I find that the plaintiffs' interpretation of ¶ 18 is the only reasonable one and that the Investment Manager must advance their reasonable litigation expenses for the Delaware Action and the Bermuda Action.
The defendants have not produced any extrinsic evidence to support their interpretation, nor have they shown that ¶ 18 can be reasonably read in two ways. Given this, I need not address the plaintiffs' argument that ¶ 18 must be construed against the Investment Manager. This contention has force because it appears that plaintiff Herenstein played no role in drafting ¶ 18 and that plaintiff Weinstock merely signed the document once it was crafted by Lazard attorneys while he was a Lazard employee. Most important, in the face of the plaintiffs' motion, the defendants have stood on their reading of the plain terms of the operating agreement, and have not submitted extrinsic evidence.