Nathan Brick (the plaintiff) served as chief operating officer of The Retrofit Source, LLC (the Operating LLC). The plaintiff also served as a member of the board of managers (Holding LLC Board) of the sole owner and manager of the Operating LLC, TRS Holdco, LLC (the Holding LLC).
The issue before the Delaware Court of Chancery in Brick v. The Retrofit Source, LLC, 2020-0254-KSJM (Del. Ch. Aug. 18, 2020) (Order), and later the Delaware Supreme Court, arose from a discovery by the Operating LLC’s officers that the company was running a “double-invoicing scheme,” which was causing it to underpay its duties to U.S. Customs and Border Protection (Customs). The officers subsequently reported the underpayment of duties to Customs and initiated an internal investigation at the Operating LLC. The Holding LLC Board terminated the plaintiff’s employment with the Operating LLC after the investigation revealed the plaintiff as a suspect who engaged in the invoicing scheme. The plaintiff also resigned as a member of the Holding LLC Board.
In response to the investigation and the plaintiff’s termination/resignation from the companies, the plaintiff submitted a letter to the companies demanding advancement for his legal fees and expenses. The companies argued that the plaintiff was not entitled to advancement or indemnification and that they reserved all rights and defenses with respect to any such claims.
The plaintiff filed an action for advancement under the Holding LLC Operating Agreement (the LLC Agreement), and the companies jointly responded through counsel that they did not believe the plaintiff was entitled to any advancement or indemnification. Shortly thereafter, the Holding LLC Board held a formal meeting and passed a board resolution denying the plaintiff’s advancement and indemnification demand.
The plaintiff then filed two additional demands for advancement, claiming that he had incurred $129,925.30 in legal fees and expenses over the course of approximately four months. The companies maintained their position that the plaintiff was not entitled to advancement or indemnification under the LLC Agreement.
The parties filed cross-motions for summary judgment. The Court of Chancery’s ruling analyzed the LLC Agreement using ordinary contract interpretation principles. According to the court, the LLC Agreement unambiguously provided for a grant of indemnification and advancement to certain “covered persons,” which was defined under the LLC Agreement to mean Holding LLC Board members. For other persons, including Holding LLC and Operating LLC officers, advancement and indemnification was subject to the Holding LLC Board’s discretion. Put differently, advancement and indemnification was discretionary for officers, but mandatory for Holding LLC Board members.
The Court of Chancery held that the plaintiff’s claims for advancement were solely “by reason of the fact” that the plaintiff was a former officer of the Operating LLC – not because he was a former member of the Holding LLC Board. Specifically, the invoicing scheme arose out of the plaintiff’s role as an officer of the Operating LLC, and was carried out as part of the plaintiff’s day-to-day management of the Operating LLC’s supply chain. Therefore, the court held that the plain terms of the LLC Agreement provided only for discretionary advancement and indemnification, and the Holding LLC Board successfully exercised its power to deny the plaintiff any advancement in his officer capacity. The Delaware Supreme Court affirmed the decision of the Court of Chancery in full.
- While Delaware corporation law provides mandatory indemnification in some circumstances, Delaware alternative entity law (e.g., the law on LLCs) does not make indemnification mandatory by law under any circumstances and gives alternative entities wide freedom of contract to craft their own indemnification scheme.
- Delaware law does not provide for any statutory advancement rights, and, therefore, advancement rights for corporate officials of any type of Delaware entity (e.g., corporations, LLCs) must be clearly provided for in governing documents, such as a certificate of incorporation, bylaws, or an LLC agreement.
- Directors, officers, and managers of Delaware entities should closely examine governing documents to determine what indemnification and/or advancement protection, if any, is conferred.
Client Alert 2021-130