On May 30, Master in Chancery Abigail LeGrow issued a master's report in Rizk v. TractManager, C.A. No. 9073-ML (Del. Ch. May 30, 2014), in which she addressed what she labeled as a Groundhog Day moment for the court: a Delaware corporation that resists advancing fees and expenses under "broad indemnification and advancement rights in bylaws or employment agreements" where the director or officer has been "accused of serious wrongdoing that allegedly injured the company.

"On this day, the company's defense centered on its argument that the petitioner had not engaged in the alleged harmful acts in his official capacity as an officer or director of TractManager, but rather the acts were taken to further his personal interests, and thus his defense of litigation addressing that conduct was not subject to advancement. LeGrow disagreed, and the report discussed in detail the test the court applies when determining whether advancement is being sought for fees and expenses that are being incurred "by reason of the fact" that the officer or director served in those capacities.

Petitioner Thomas Rizk was the founder of TractManager and served as its CEO as well as a member of its board of directors. In late 2012, a private equity investor purchased a majority interest in TractManager and installed three directors on the board. As the master's report describes it, those directors quickly discovered "serious improprieties" in the company's recordkeeping and expenses and that Rizk (and others) had used company credit cards upon which they "routinely incurred substantial charges on questionable activities." Rizk was terminated as CEO, and was asked to resign as a director.

In April 2013, Rizk went on the offensive and filed a suit against TractManager alleging, generally, that he was improperly terminated. Rather than merely respond to and fight the improper-termination claims, TractManager similarly went on the counteroffensive and filed counterclaims alleging nine different claims against Rizk. "The theme running through the New Jersey counterclaims is that Rizk engaged in mismanagement and impropriety in connection with managing [TractManager] and allocating expenses to the company, and that ... Rizk took affirmative steps to conceal the wrongdoing by deleting [TractManager's] information, including emails, from the company's computers and servers." The counterclaims go on to allege that the challenged conduct occurred "with the express or tacit approval" of Rizk.

In addition to the counterclaims asserted in the New Jersey litigation, TractManager also sued Rizk (and others) in New York, asserting a breach of contract claim for purported breaches of representations and warranties in the transaction in which the private equity investor purchased its interest.

Rizk demanded advancement of the fees and expenses he was incurring in both the New Jersey and New York litigation pursuant to a mandatory advancement bylaw that provided for advancement where the officer or director was made a party to litigation "by reason of the fact that he or she is or was a director or officer of the corporation." This right to advancement was conditioned only on the delivery of an undertaking to repay the sums advanced if it were later determined that the officer or director was not entitled to advancement. TractManager refused the demands for advancement.

In resolving this dispute, LeGrow applied what she called "well-worn" authority stating that a proceeding is "by reason of the fact" that a person served as an officer or director "if there is a nexus or causal connection between the underlying proceeding and one's official capacity" notwithstanding "one's motivation for engaging in that conduct." Moreover, that connection will be deemed established where "the corporate powers were used or necessary for the commission of the alleged misconduct, even if the cause of action does not specify a claim for breach of fiduciary duty."

In applying that standard to the counterclaims in the New Jersey action, LeGrow rejected the company's contention that the claims were asserted against Rizk in his personal capacity under various contracts and that evidence of that could be found in the fact that Rizk could have engaged in any of the challenged conduct as a regular employee (as opposed to an officer or director). LeGrow noted that the court had ordered advancement when an officer is alleged to have violated an employment agreement where: "(1) the conduct at issue was identical to conduct alleged to be a breach of fiduciary duty, or (2) the contractual claims are grounded in an official's alleged misuse of the substantial fiduciary responsibility he was given." LeGrow ordered advancement for all of the counterclaims in the New Jersey action.

In addressing the New York action, she recognized that the claims in this action-that Rizk breached representations and warranties in the merger transaction-"carr[y] more persuasive force." Nevertheless, LeGrow found that the claims were properly subject to advancement because the "allegations regarding Rizk's conduct as CEO creat[ed] the necessary causal connection between the New York action and Rizk's official capacity." This is so because his defense "necessarily will require Rizk to defend his actions as CEO, and possibly disprove allegations that he acted improperly in that capacity."

Richard L. Renck is a partner in Duane Morris' Wilmington office. His practice focuses on complex corporate and commercial litigation, including actions relating to the Delaware General Corporation Law and common-law fiduciary duties, as well as advising corporate boards, directors and committees of boards in high-stakes litigation and counseling directors and senior executives regarding issues of corporate governance.

Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.