The opinion of the court was delivered by: MORRIS E. LASKER
Norton Waltuch brings this action for indemnification of $ 2,346,586.67 in legal expenses and related cost against his former employer, ContiCommodity Services, Inc. ("Conti") and its parent corporation, Continental Grain Company ("Conti Grain"). All these costs arose out of litigation in connection with Waltuch's activities in the silver market as an employee of Conti in 1979-80. Waltuch's indemnity claims are based on provisions of Conti's Certificate of Incorporation and by-laws as well as Delaware General Corporation Law.
Approximately two months later, Waltuch commenced this action. Waltuch now moves for summary judgment on his claim against Conti under Article Ninth of the Certificate of Incorporation and Section 42(c) of Conti's by-laws (Counts I and III). Conti has cross-moved for summary judgment dismissing the complaint in its entirety and for summary judgment on its second counterclaim seeking recoupment of $ 1,100,864.48 advanced to Waltuch to pay his legal fees. In addition, Conti Grain moves for an order dismissing the complaint for failure to state a cause of action against it.
The motions are disposed of as follows. Waltuch's motion for summary judgment is granted with respect to the expenses actually and reasonably incurred by him in defending the Michelson action and otherwise denied. Conti's motion for summary judgment is granted with respect to Waltuch's claim under Section 42(c) of Conti's by-laws with the exception of the Michelson expenses, granted with regard to Waltuch's claim for punitive damages, and otherwise denied. Conti Grain's motion to dismiss the complaint for failure to state a cause of action against it is denied as to Counts II, IV and VI of the complaint and, as to Count VII, shall be treated as a motion for summary judgment as detailed in Section VII.
Conti's first line of defense is that the Special Committee's decision not to indemnify Waltuch is protected by the business judgment rule and that the merits of its conclusion are therefore immune from de novo review by a court. Conti maintains that decisions regarding indemnification are analogous to other corporate decisions which have been held to be protected by the business judgment rule, such as a decision to refuse a shareholder demand to commence litigation. Conti also points out that the Delaware indemnification statute in some cases requires the corporation itself to determine whether the indemnitee has met the applicable standard of conduct for indemnification "unless ordered by a court." It argues that there would be little point to this procedure if the corporation's findings could subsequently be entirely disregarded by disgruntled claimants.
Waltuch responds that the business judgment rule is intended to protect directors against shareholder suits challenging their business decisions. He argues that the Special Committee's decision not to indemnify Waltuch was not a business decision and points out that, in any event, Waltuch's suit is not a shareholder action.
The business judgment rule is "a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). Where the rule applies, the directors' decisions "will not be disturbed if they can be attributed to any rational business purpose. A court under such circumstances will not substitute its own notions of what is or is not sound business judgment." Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971).
Conti points out that, in the case of shareholder suits, Delaware courts have held decisions by corporate directors declining to sue officers and directors for breaches of fiduciary duty, to be protected by the business judgment rule. Zapata Corp. v. Maldonado, 430 A.2d 779, 784 n.10 (Del. 1981); Accord Allison v. General Motors Corp., 604 F. Supp. 1106, 1120 (D. Del.), aff'd mem., 782 F.2d 1026 (3d Cir. 1985). However, this is not such a case.
Plaintiff here is not a shareholder and the question is not whether the corporation should sue an officer or director. The business judgment rule therefore does not apply.
Dennis J. Block et al., The Business Judgment Rule: Fiduciary Duties of Corporate Directors and Officers 2-3 (2d ed. 1988) (emphasis added). "Although it is customary to think of the business judgment rule as protecting directors from stockholders, it ultimately serves the more important function of protecting stockholders from themselves." Dooley & Veasey, "The Role of the Board in Derivative Litigation: Delaware Law and the Current ALI Proposals Compared," 44 EBus. Law.F 503, 522 (1989). The business judgment rule recognizes that "stockholders give the directors a mandate to oversee the countless business decisions which must be made daily in the course of managing an enterprise." E. Norman Veasey & William F. Mongan, Fiduciary Duties of Directors in Control Contests, 592 PLI/Corp. 449, 460 (Jan. 11, 1988). The rule prevents the shareholders from meddling in these decisions because they have delegated responsibility for the day to day business of running the corporation to the directors.
Conti cites to Gehrhardt v. General Motors, 581 F.2d 7 (2d Cir. 1978), and Gitelson v. Du Pont, 17 N.Y.2d 46, 215 N.E.2d 336, 268 N.Y.S.2d 11 (1966), as examples of cases in which the business judgment rule has supposedly been applied in a "broader arena of corporate affairs." These cases do not mention the business judgment rule. Instead, they concern contractual provisions specifying that the corporation has the sole authority to determine certain employment related matters.
Whatever merit there may be to Conti's policy argument -- that there is little point to corporate indemnity decisions pursuant to the Delaware statute if these determinations are not accepted by a court -- it does not change the scope of the business judgment rule.
Since the business judgment rule does not apply to the Special Committee's rejection of Waltuch's indemnification claim, the merits of that determination must be examined de novo.
Count I of the complaint sets forth Waltuch's indemnification claim against Conti under Article Ninth of Conti's Certificate of Incorporation. Article Ninth provides:
The Corporation shall indemnify and hold harmless each of its incumbent or former directors, officers, employees and agents . . . against expenses actually and necessarily incurred by him in connection with the defense of any action, suit or proceeding threatened, pending or completed, in which he is made a party, by reason of his serving in or having held such position or capacity, except in relation to matters as to which he shall be adjudged in such action, suit or proceeding to be liable for negligence or misconduct in the performance of duty.
The Special Committee denied the claim on the grounds that indemnification would violate the public policy limitations expressed in Section 145 of the Delaware General Corporation Law. Both Conti and Waltuch move for summary judgment.
There is no dispute that Article Ninth is facially satisfied since Waltuch has not been "adjudged . . . liable for negligence or misconduct in the performance of duty." Nevertheless, Conti argues that Article Ninth cannot be enforced as literally written because to do so would violate Section 145 of the Delaware General Corporation Law which requires a person seeking indemnification to show that he acted in good faith and in a manner he reasonably believed to be in or not opposed to the corporation's best interests. Conti contends that Waltuch cannot meet that burden and accordingly is not entitled to indemnification.
Article Ninth, by itself, does not "end the matter." Conti's Certificate of Incorporation is subject to the law of Delaware. Section 102(b)(1) of the Delaware General Corporation law specifically provides that a certificate of incorporation may include "any provision for the management of the business and conduct of the affairs of the corporation . . . if such provisions are not contrary to the laws of this State." Del. Gen. Corp. L. § 102(b)(1). Accordingly, Waltuch cannot recover under Article Ninth unless he can also satisfy the requirements of Section 145 of the Delaware General Corporation Law.
Section 145 is the statutory authority for indemnification. It applies to any person involved in actual or threatened litigation or an investigation by reason of the status of such a person as an officer, director, employee or agent of the corporation. Subsections (a) and (b) of the statute permit indemnification by the corporation "against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred" provided that the indemnitee "acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation." Subsection (c) mandates indemnification against "expenses (including attorneys' fees) actually and reasonably incurred" if the indemnitee "has been successful on the merits or otherwise in defense of any action suit or proceeding referred to in subsections (a) and (b), or in defense of any claim, issue or matter therein."
These provisions are all critically affected by the language of subsection (f) which provides:
The indemnification provided by this section shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any by-law, agreement, vote of stockholders or disinterested directors or otherwise.
The dispute between the parties concerns the meaning of subsection (f) - the so-called "non-exclusive" clause. Waltuch argues that subsection (f) provides for indemnification rights beyond those provided elsewhere and that, in any event, Article Ninth satisfies whatever public policy limitations there may be on indemnification under subsection (f).
Conti insists that Delaware public policy does not permit indemnification beyond the limitations set out in the other subsections of Section 145, including the good faith requirement set out in subsection (a). In other words, Conti maintains that Waltuch cannot be indemnified unless he can show that the good faith requirement of subsection (a) is satisfied, even though subsection (f) states that "the indemnification provided by this section shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled."
There is no question that subsection 145(f) allows a corporation to "grant indemnification rights beyond those provided by the [rest of] the statute." Hibbert v. Hollywood Park, Inc., 457 A.2d 339 (Del. 1983). However, subsection (f) is not a blanket authorization to indemnify directors or officers against all expenses of whatever nature regardless of conduct. S. Samuel Arsht, Indemnification Under Section 145 of the Delaware General Corporation Law, 3 Del. J. Corp. L. 176, 176-77 (1978). Although one court has described the other subsections of Section 145 as "simply 'fall back' provisions which a Delaware corporation may or may not adopt," PepsiCo, Inc. v. Continental Casualty Co., 640 F. Supp. 656, 661 (S.D.N.Y. 1986), other courts and commentators agree that "it is questionable whether a Delaware court would be quite this sweeping in its language in a case properly presented to it involving the outer limits of the authority provided in Section 145(f)." R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations and Business Organizations § 4.16, at 4-318 (2d ed. Supp. 1992).
Be that as it may, it has been generally agreed that there are public policy limits on indemnification under Section 145(f). This was already clear under Section 145's predecessor, Delaware Corporation Law § 2(10). Mooney v. Willys-Overland Motors, 204 F.2d 888 (3d Cir. 1953). In that case, the court found that Mooney was entitled to reimbursement for his legal expenses under an employment contract with the corporation. Chief Judge Biggs noted that the contract provided an independent legal basis for indemnification and that no overriding reference to the Delaware statute was necessary because of that statute's non-exclusive provision. However, he also implied that there were limits on indemnification under the non-exclusive provision, noting that "Delaware Corporation Law § 2(10) and [the corporation's by-law] have met the requirements of public policy by the realistic limits they set upon the right of indemnification." Id. at 896.
Similarly, with regard to the present statute, it has been held that "it is generally accepted that an agreement to indemnify within section 145(f), to survive into enforceability, must be able to withstand an attack on grounds of policy or basic equity, that is, a defense amounting to illegality," Choate, Hall & Stewart v. SCA Servs., Inc., 22 Mass. App. Ct. 522, 495 N.E.2d 562, 566 (Mass. App. Ct. 1986).
Green v. Westcap Corp., 492 A.2d 260 (Del. Super. 1985) is also instructive. In that case the plaintiff sought indemnification under section 145(c) for legal expenses incurred successfully defending criminal charges brought against him by the State of Texas. The court stated:
The objective of the indemnification provision is to assure that indemnification can or will be invoked by the corporation for its directors and officers who incur expenses in proving their honesty and integrity, unless they fail to meet minimum qualifications touching upon the concept of wrongdoing.
The more difficult question is to define precisely what limitations on indemnification public policy imposes. Waltuch maintains that Article Ninth of Conti's Charter -- which requires that the indemnitee has not been adjudged liable for negligence or misconduct in the performance of duty -- by itself satisfies Delaware public policy. He relies primarily on Mooney in which Delaware Corporation Law § 2(10), which is practically identical to Article Ninth of Conti's charter, was held to satisfy Delaware public policy.
Reliance on Mooney is misplaced, however, for the reason that Section 2(10) was replaced by Delaware General Corporation Law Section 145 in 1967 and the new statute no longer explicitly permits indemnification merely because the indemnitee has not been adjudged liable for negligence or misconduct. In fact, the opposite conclusion seems more persuasive: perhaps that provision was changed because the drafters of the new statute concluded that it did not satisfy public policy. An article written at the time gives support to this interpretation of the changes made by the 1967 amendment:
As far as Delaware law was concerned, the existing statutory provisions on the subject [of indemnification] had been found to be inadequate. Numerous by-laws and charter provisions had been adopted clarifying and extending its terms, but uncertainty existed in many instances as to whether such provisions transgressed the limits which the courts had indicated they would establish based on public policy.
S. Samuel Arsht & Walter K. Stapleton, Delaware's New General Corporation Law: Substantive Changes, 23 Bus. Law. 75, 79-80 (1967).
What guidance there is on the precise limits to indemnification imposed by public policy comes from commentators. To the extent that they have addressed the subject, they side with Conti's position. Thus, one commentator has expressly stated that "any agreement or by-law adopted pursuant to the authority of Section 145(f) would be subject to the public policy limitations reflected by the specific statutory provisions" of the rest of section 145. Balotti & Finkelstein, supra, § 4.16, at 4-320. Another has agreed, albeit more tentatively, that "an argument can be made that indemnification which is uncategorically prohibited under subsections (a) and (b) . . . [is] contrary to public policy and hence cannot be the subject of subsection (f) indemnification." A. Gilchrist Sparks, III et al., Indemnification, Directors and Officers Liability Insurance and Limitations of Director Liability Pursuant to Statutory Authorization: The Legal Framework under Delaware Law, 696 PLI/Corp. 941, 976 (May 7, 1990). Finally, one commentator has noted that "although there is no case law on point, it is probable that a Delaware court would not allow indemnification . . . when it is prohibited by law or public policy. To the extent that the statute can be read to embody the public policy limitations of indemnification, a by-law or agreement purporting to expand these limits would likely be void as violative of public policy." E. Norman Veasey et al., Delaware Law Supports Directors with a Three-Legged Stool of Limited Liability, Indemnification, and Insurance, 42 Bus. Law. 399, 414 (1987).
In addition to the weight of this authority, there is a compelling argument on Conti's side. It is simply that there would be no point to the carefully crafted provisions of Section 145 spelling out the permissible scope of indemnification under Delaware law if subsection (f) allowed indemnification in additional circumstances without regard to these limits. The exception would swallow the rule.
It is not true, as Waltuch maintains, that on this approach, the rule swallows the exception. Even when circumscribed by the limitations set forth in the other subsections, subsection (f) still "may authorize the adoption of various procedures and presumptions to make the process of indemnification more favorable to the indemnitee without violating the statute." Balotti & Finkelstein, supra, § 4.16, at 4-320.
In sum, subsection (f) does not permit indemnification without regard to the limitations set forth in the other subsections of Section 145. Thus, Waltuch must show either that he "acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation" or that he "has been successful on the merits or otherwise" in defense of the actions against him. These questions are addressed below in Sections III and ...