Corporate
NOVEMBER 2002
Can Directors And Officers Recover From Their Corporation
Fees They Incurred To Obtain Indemnity From The Corporation
Under Applicable Indemnification Agreements And Bylaws?
New York And Delaware Courts Take Different Approaches
INTRODUCTION
Two recent court decisions — one from the United
States Court of Appeals for the Second Circuit,
interpreting New York law, and one from the Supreme
Court of Delaware, applying Delaware law — highlight
an issue of potential importance to companies and their
directors and officers: whether an officer or director of a
company who incurs costs in overcoming the
company’s refusal to provide indemnification has a right
to obtain from the company reimbursement of costs,
including especially attorneys’ fees, associated with
obtaining the indemnification. Such costs, sometimes
known as “fees on fees,” can be substantial, especially
because the individual director or officer may be
incurring costs in defending himself or herself against
an underlying claim. Moreover, in today’s business
climate in which disputes between companies and their
directors or officers regarding corporate indemnification
for third-party claims against the directors or officers
may become more common, the issue of whether “fees
on fees” will be recoverable takes on heightened
significance.
THE RECENT COURT DECISIONS
The Delaware Approach
A June 13, 2002 decision of the Supreme Court of
Delaware in a case entitled Stifel Financial Corp. v.
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Cochran1 and a July 23, 2002 decision of the United
States Court of Appeals for the Second Circuit in a
case entitled Baker v. Health Management Systems,
Inc.2 illustrate that New York and Delaware law differ
on whether, and how, an officer or director may
obtain reimbursement from his or her company of the
costs of obtaining indemnification from the company.
In Cochran, a former officer and director, Robert
Cochran (“Cochran”), of a subsidiary of Stifel
Financial Corp. (“Stifel”), a regional investment
banking carrier, sought indemnification from Stifel of
the costs associated with successfully defending
fraud claims that arose out of Cochran’s municipal
bond underwriting work for Stifel. Cochran also
sought reimbursement of the costs associated with
prosecuting his indemnification claim against Stifel
(“fees on fees”). Stifel’s bylaws contained a
provision stating that Stifel “shall indemnify to the
full extent authorized by law any person made or
threatened to be made a party to any action, suit, or
proceeding, whether criminal, civil, administrative or
investigative, by reason of the fact that he . . . is or
was a director, officer or employee of the Corporation
. . ..” Cochran argued that because Stifel’s bylaws
provided for indemnification to the “fullest extent
permitted by law” and there is no express prohibition
against recovery of “fees on fees” in Delaware’s
2002 WL 1316240 (Del. Super.).
298 F.3d 146 (2d Cir. 2002).
Kirkpatrick & Lockhart LLP
statutes, recovery of “fees on fees” should be
allowed. In response, Stifel argued that because
reimbursement of “fees on fees” is not clearly
provided for by the Delaware statute regarding
corporate indemnification (8 Del.C. §145),
indemnification for such fees is not available under
Delaware law. The Supreme Court of Delaware
agreed with Cochran, stating:
[T]he indemnification statutes are intended to be
remedial in nature. An attorney representing a
former director who is being denied statutorily
authorized indemnification must seek compensation
from his client or remain uncompensated, a result
‘inimical to the interests’ of the former director and
contrary to the express purpose of [Delaware’s
statutory indemnification provision] to protect
directors from personal liability for corporate
expenses.
[T]he language of [Delaware’s statutory indemnification
provision] permitting indemnification to a party ‘in
any action’ can be read literally to encompass the
indemnification action itself. . . . This Court has
emphasized that the indemnification statute should
be broadly interpreted to further the goals it was
enacted to achieve. . . . The invariant policy of
Delaware legislation on indemnification is to
‘promote the desirable end that corporate officials
will resist what they consider unjustified suits and
claims, secure in the knowledge that their reasonable
expenses will be borne by the corporation they have
served if they are vindicated.’ . . . Beyond that, its
larger purpose is ‘to encourage capable men to serve
as corporate directors, secure in the knowledge that
expenses incurred by them in upholding their honesty
and integrity as directors will be borne by the
corporation they serve.’
We hold that indemnification for expenses incurred
in successfully prosecuting an indemnification suit
are permissible under [Delaware’s statutory
indemnification provision], and therefore ‘authorized
by law.’ Allowing indemnification for the expenses
incurred by a director in pursuing his indemnification
rights gives recognition to the reality that the
corporation itself is responsible for putting the
director through the process of litigation. Further,
giving full effect to [Delaware’s statutory provision]
prevents a corporation from using its ‘deep pockets’
to wear down a former director, with a valid claim to
indemnification, through expensive litigation.
Finally, corporations will not be unduly punished by
this result. They remain free to tailor their
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indemnification bylaws to exclude ‘fees on fees,’ if
that is a desirable goal.3
The Cochran decision overturned several earlier
Delaware Chancery Court decisions that had not
allowed recovery of “fees on fees” in the absence of
an express agreement providing for recovery of such
fees.
The New York Approach
The United States Court of Appeals for the Second
Circuit in Baker reached a different result when
interpreting NewYork law. In Baker, a former officer,
Phillip Siegel (“Siegel”), of Health Management
Systems, Inc. (“HMS”) was named as one of several
defendants in a securities fraud lawsuit. After
retaining separate counsel and obtaining his
dismissal from that lawsuit, Siegel sought
indemnification from HMS of the costs associated
with defense of the securities fraud lawsuit. Other
defendants paid $4 million to settle the remainder of
the case. HMS determined that Siegel’s retention of
separate counsel was unnecessary and denied
Siegel’s request for indemnification, Siegel sought to
enforce his right to indemnification in federal court,
and the federal court ordered partial indemnification.
The court, however, denied Siegel’s request that his
“fees on fees” — the costs associated with litigating
to enforce the right to indemnification — be
reimbursed. Siegel appealed the ruling on “fees on
fees,” and the United States Court of Appeals for the
Second Circuit, recognizing that whether New York’s
indemnification statute provides for recovery of “fees
on fees” was an important question of New York law,
certified this question to the New York Court of
Appeals:
Where a corporate officer is ‘successful’ in the defense
of an underlying action, within the meaning of [the]
New York Business Corporation Law [provision
regarding indemnification], where the corporation
unsuccessfully contests the duty to indemnify and
contests with partial success the amount of
indemnification, and where there is no bad faith on
the part of the corporation, does the phrase
‘attorneys’ fees actually and necessarily incurred as
2002 WL 1316240, *6-7 (citations omitted).
KIRKPATRICK & LOCKHART LLP CORPORATE ALERT
a result of such action or proceeding,’ as used in [the]
New York Business Corporation Law [provision],
provide for recovery of reasonable fees incurred by a
corporate officer in making an application for fees
before a court . . .?4
The New York Court of Appeals answered the
question in the negative, finding that the “fees on
fees” do not have a reasonable nexus to the
underlying suit. It stated that “it stretches language
beyond the outer limits of meaning to claim that [the
‘fees on fees’] were necessarily incurred by reason of
the joinder of [Siegel] in the securities fraud suits.”5
The United States Court of Appeals for the Second
Circuit accepted the New York Court’s interpretation
of New York law and rejected Siegel’s request for
recovery from HMS of his “fees on fees.”6
IMPLICATIONS OF THE DECISIONS
Delaware and New York law plainly differ as to
whether an officer or director may recover “fees on
fees” associated with obtaining indemnification
under a corporation’s bylaws or an indemnification
agreement in the absence of express language in the
bylaws or agreement indicating how “fees on fees”
will be treated. While Delaware and New York are
two states in which a large number of corporations
are incorporated, other states’ laws also will apply to
some corporations. Courts in many jurisdictions
have not yet addressed the issue decided in Cochran
and Baker and may not arrive at consistent results
when they do so. Where many states’ laws
ultimately may not differ, however, is on the question
of whether a corporation and its directors and
officers can determine with clarity, in advance,
whether “fees on fees” will be recoverable. The
Cochran decision, while holding that Delaware law
will allow recovery of “fees on fees” in the absence
of specific language in bylaws or an agreement,
expressly stated that a corporation may disallow
recovery of “fees on fees” by inserting appropriate
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language in its bylaws or indemnification agreements.
The Baker decision suggested that recovery of “fees
on fees” would be possible under New York law if
provided for expressly in an indemnification
agreement.
FINAL THOUGHTS
1. The question of whether an officer or director will
be able to recover “fees on fees” associated with
successfully pursuing indemnification from his or
her corporation is, for obvious reasons, an
important one for individual officers and directors
and for corporations.
2. Under the law of some states, such as Delaware, if
directors and officers successfully pursue an
indemnification claim against the corporation, they
will be entitled to recover their “fees on fees,” at
least where the corporation has agreed to
indemnify them to the fullest extent allowed by law
and has not excluded “fees on fees” recovery from
the indemnification.7
3. Under the law of some other states, such as New
York, under similar circumstances, “fees on fees”
will not be recoverable unless expressly provided
for by the parties.
4. The law regarding recovery of “fees on fees” is
unsettled in many other jurisdictions.
5. As in Cochran and Baker, many corporations and
their directors and officers have not explicitly
referenced, in advance, the indemnifiability, or
non-indemnifiability, of “fees on fees.”
6. Whether “fees on fees” can and should be
addressed in advance will depend on particular
facts and circumstances. Nevertheless,
corporations, on the one hand, and directors and
officers, on the other hand, may wish to consider
298 WL at 148.
Id. at 149.
The Baker case did not address whether attorneys’ fees and costs associated with enforcing a right to indemnity may be
recoverable under some theory of liability other than indemnity pursuant to a company’s bylaws, indemnification
agreements or state laws regarding corporate indemnification. For example, the Baker decision did not address whether fees
might be available from a corporation if the corporation acted in bad faith.
Indeed, the Model Business Corporation Act expressly provides for recovery of “fees on fees” in certain instances where an
indemnitee has been successful in asserting indemnification rights. See, e.g., MBA § 8.54(b).
NOVEMBER 2002
Kirkpatrick & Lockhart LLP
specifically addressing in advance the “fees on
fees” issue in their documents governing
indemnification. For example, (i) in a matter
involving New York law, they may wish to ensure
recovery of “fees on fees;” (ii) in a matter
involving Delaware law, they may wish to ensure
that such fees are not recoverable; or (iii) in a
matter involving unsettled state law, they may
wish to minimize uncertainty over the issue.
7. Corporations and their directors and officers may
also wish to consider adding language to their
indemnification agreements, making clear whether
or not the company will advance “fees on fees” to
its directors and officers as incurred, as opposed
to after completion of an action seeking to enforce
indemnification rights.
8. Another matter Cochran and Baker do not
address, but that may become important in the
future, concerns whether directors and officers
will be entitled to be indemnified for attorneys’
fees and costs incurred pursuing directors and
officers liability insurance coverage. Uncertainty
regarding the right to be indemnified for these
types of fees also potentially can be minimized as
a contractual matter by inserting in the relevant
documents clear language either allowing or
disallowing such indemnification.
THOMAS M. REITER
treiter@kl.com
412.355.8274
ALAN W. TAMARELLI, JR.
atamarelli@kl.com
412.355.8685
FOR ADDITIONAL INFORMATION concerning this topic or any Corporate issue,
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Thomas F. Cooney, III
214.939.4906
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© 2002 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.