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IN RE HEALTH MANAGEMENT SYSTEMS

February 4, 2000

IN RE HEALTH MANAGEMENT SYSTEMS, INC. SECURITIES LITIGATION.


The opinion of the court was delivered by: Berman, District Judge.

DECISION AND ORDER

This securities fraud class action was filed on March 17, 1997 (the "Action").*fn1 Plaintiffs alleged that Defendants, Health Management Systems, Inc. ("HMS")*fn2, and certain of its officers and directors including Defendant Philip Siegel ("Siegel"), the former Chief Financial Officer for HMS, disseminated false and misleading statements designed unlawfully to inflate the price of HMS stock.

On August 6, 1998, a stipulation dismissing Siegel from the Action "with prejudice" was executed by Plaintiffs and Siegel.*fn3 Siegel was and is individually represented by Dennis J. Block, Esq. and Michelle Roth, Esq. of Cadwalader, Wickersham & Taft.*fn4 Initially, HMS refused to indemnify Siegel for the attorneys' fees and expenses that he incurred in connection with his defense in the Action arguing, among other things, that the legal fees sought were neither reasonable nor necessarily incurred because Siegel did not need representation separate from the other Defendants.*fn5 HMS's refusal to provide indemnity has precipitated the instant proceeding.

In November 1998, Siegel filed a motion, pursuant to the New York Business Corporation Law ("BCL") and the by-laws of HMS, for an order requiring HMS to indemnify him for his attorneys' fees and expenses.*fn6 In June 1999, the Court referred Siegel's motion for indemnification to United States Magistrate Judge James C. Francis IV. Oral argument was held before Judge Francis on September 9, 1999. While the matter was pending before Judge Francis, HMS conceded that it was appropriate for Siegel to be independently represented; HMS continued to argue that the fees incurred by Siegel were not reasonable. On October 25, 1999, Judge Francis issued a Report and Recommendation ("Report") recommending that Siegel be awarded indemnification against HMS for "$60,959.50 in attorneys' fees and $6,677.23 in expenses, for a total of $67,636.73." (Report at 237). Judge Francis disallowed $17,147.64 on the grounds that that amount of fees and costs was incurred in attempting to secure indemnification (so-called "fees on fees").

In his Report, Judge Francis clearly advised and notified the parties of the procedures for objecting to the Report, stating that "[p]ursuant to Rule 72 of the Federal Rules of Civil Procedure, the parties shall have ten (10) days from this date to file written objections to this Report and Recommendation." (Report at 237). On or about November 8, 1999, both HMS and Siegel filed timely objections to the Report. In summary, Siegel argues that he should be awarded "all of the fees he has incurred in seeking to enforce his indemnification obligation against the Company [HMS]." (Siegel's Objections dated November 8, 1999 at 25). HMS asserts that the Report should be "rejected to the extent it recommends reimbursement of Siegel's legal fees, pending the conduct by this Court of the mandatory Reform Act review and a determination of the propriety, for Rule 11 purposes, of plaintiffs' having named Siegel as a defendant." (HMS's Objections dated November 8, 1999 at 4).

This Court may adopt those portions of the Report to which no objections have been made and which are not facially erroneous. See Pizarro v. Bartlett, 776 F. Supp. 815, 817 (S.D.N.Y. 1991); Nelson v. Smith, 618 F. Supp. 1186, 1189 (S.D.N.Y. 1985). The Court conducts a de novo review of those portions of the Report to which objections have been made. See Pizarro, 776 F. Supp. at 817. "Because 28 U.S.C. § 636(b) requires a `de novo determination' rather than a de novo hearing, the district court is free to place `whatever reliance . . . in the exercise of sound judicial discretion, [it chooses] to place on a magistrate's proposed findings and recommendations.'" Pizarro, 776 F. Supp. at 817 (quoting Grassia v. Scully, 892 F.2d 16, 19 (2d Cir. 1989)).

The Court has undertaken a de novo review of the record and the law and, following such review, is in agreement with all of Judge Francis' conclusions in every material respect. The Report is adopted in its entirety. The Court will, however, briefly discuss three issues raised in the parties' objections.

First, Siegel argues that it is unfair to conclude, as Judge Francis did, that his "right to be indemnified does not include the right to be reimbursed for the costs and fees he incurred" in order to secure such indemnification (i.e., fees on fees). (Siegel's Objections dated November 8, 1999 at 2). This is by no means the first time that the issue of "fees on fees" has arisen. The general rule for resolving this (indemnity) issue was stated by the New York Court of Appeals as follows: "Inasmuch as a promise by one party to a contract to indemnify the other for attorney's fees incurred in litigation between them is contrary to the well-understood rule that parties are responsible for their own attorney's fees, the court should not infer a party's intention to waive the benefit of the rule unless the intention to do so is unmistakably clear from the language of the promise." Hooper Associates, Ltd. v. AGS Computers, Inc., 74 N.Y.2d 487, 549 N.Y.S.2d 365, 548 N.E.2d 903 (1989) (citations omitted) (emphasis added). Although acknowledging that some courts have awarded fees on fees*fn7, Judge Francis could find no "unmistakably clear" language here supporting an award of fees on fees to Siegel.*fn8 See Bridgestone/Firestone, Inc. v. Recovery Credit Services, Inc., 98 F.3d 13, 20-21 (2d Cir. 1996). This Court agrees. See Mayer v. Executive Telecard, Ltd., 705 A.2d 220 (Del.Ch. 1997).

The Court recognizes, as did Judge Francis, that there may be an element of illogic in denying fees on fees. After all, the purpose of indemnity is to make someone whole. In light of existing precedents, however, the Court believes that the appropriate resolution of this problem is to amend the applicable instrument, be it a contract or a corporate by-law, explicitly to authorize fees on fees*fn9, rather than to conclude that language which is ambiguous is, actually, "unmistakably clear." See Mayer, 705 A.2d at 223 ("the Delaware General Assembly apparently has concluded that allowing mandatory indemnification for fees incurred in the underlying action is an adequate incentive, without also requiring indemnification of the fees incurred by the claimant in the indemnification action itself. Reasonable persons may disagree with that judgment, i.e., whether `fees for fees' is also needed as a further incentive for capable persons to serve as directors or officers of Delaware corporations. In the end, however, that judgment is legislative, not judicial"); Chamison v. HealthTrust, Inc., 735 A.2d 912, 926 (Del.Ch.1999) (citing Mayer, the Court stated that "[o]rdinarily, under Delaware law, a successful suit for indemnification does not entitle the successful director or officer to recover `fees for fees'"). See also Canpartners Investments IV, LLC v. Alliance Gaming Corp., 981 F. Supp. 820, 826-27 (S.D.N.Y. 1997).

Second, Siegel asserts that HMS should be obligated to reimburse him "for all his costs he incurred in prosecuting the instant application because the incurrence of such fees was entirely the result of the Company's [HMS] unreasonableness, bad faith conduct, and dilatory tactics in connection with Mr. Siegel's efforts to recover the costs of his legal representation in the Action to which he is absolutely entitled." (Siegel's Objections dated November 8, 1999 at 21). The Court of Appeals for the Second Circuit has held that "[u]nder the inherent power of the court to supervise and control its own proceedings, an exception to the American Rule has evolved which permits the court to award a reasonable attorneys' fee to the prevailing party when the losing party has `acted in bad faith, vexatiously, wantonly, or for oppressive reasons . . .'" Oliveri v. Thompson, 803 F.2d 1265, 1272 (2d Cir. 1986), cert. denied, 480 U.S. 918, 107 S.Ct. 1373, 94 L.Ed.2d 689 (1987) (citation omitted). The Second Circuit has also cautioned that "[t]his circuit has interpreted the standard restrictively." Id.

The determination of whether HMS's conduct vis-a-vis Siegel's indemnity rose to the level of bad faith is regrettably a very close call. HMS's initial determination to resist indemnification arguing that Siegel had no need for separate representation was untenable. It should have been clear to HMS from the start that Siegel's unique circumstances (i.e., the fact that he joined HMS three months after the alleged fraudulent conduct had commenced and the fact that, unlike the other individual Defendants, he had purchased rather than sold HMS stock at the allegedly inflated price) warranted separate representation. On the other hand, HMS backed away from this initial position. As Judge Francis explained in the Report: "[i]n its initial response to [Siegel's] application, HMS contended that the fees sought were neither reasonable nor necessarily incurred because Mr. Siegel had no need for separate representation. Thereafter, the company modified its position and now concedes that it was appropriate for Mr. Siegel to be independently represented. However, HMS continues to argue that the fees incurred were not reasonable, and that indemnification should be limited to the `value added' by Mr. Block to the work done by Skadden on behalf of all defendants." (Report at 5-6). But for this change in position, HMS's conduct may well have justified an award of additional fees to Siegel. See Dunlap v. Sunbeam Corp., 1999 WL 1261339 at * 6 (Del.Ch. July 9, 1999) ("[w]hile this Court has on occasion awarded `fees for fees,' I do not find Sunbeam's actions in disputing this matter to be so egregious or in such bad faith as to require that special form of discipline").*fn10

Third, HMS argues that Siegel breached his duty to HMS and, therefore, forfeited his right to indemnification, by including a waiver of attorneys' fees in the stipulation pursuant to which the claims against him were dismissed. HMS asserts that "the Magistrate Judge left HMS in the position of having to reimburse Siegel for fees which the Court may well find should never have had to be incurred (by virtue of Siegel's wrongful inclusion in the lawsuit), but without the means (soley by virtue of Siegel's gratuitous act) of being made whole." (HMS's Objections dated November 8, 1999 at 3-4). HMS's argument is not persuasive.*fn11

HMS's argument, in this regard, stands logic on its head by suggesting that Siegel should have remained as a defendant in the Action — thereby, incidentally, incurring additional legal fees and expenses — rather than achieve dismissal with prejudice. Siegel persuasively points out that "there is no authority — and the Company [HMS] cites none — that stands for the proposition that by waiving his right to seek sanctions against plaintiffs' counsel Mr. Siegel has fortified [sic]*fn12 his right to indemnification from the Company." (Siegel's Opposition to HMS's Objections dated December 3, 1999 at 5). And, in any event, as HMS also concedes "[e]ven though Siegel was dismissed out (and subsequently stipulated out of the case he was no longer in), that dismissal does not preclude the court's review of the sanctions issue as respects Siegel . . ." (HMS's Objections dated November 8, 1999 at 3).

Conclusion and Order

Accordingly, the Court incorporates the Report by reference and, for the reasons set forth herein, directs that Siegel forthwith be awarded indemnification against HMS for $60,959.50 in attorneys' fees ...


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