Wednesday, July 21, 2010

Employer Must Watch For Broad Use of Employee Indemnification and Advancement Rights (James River Mgmt. v. Kehoe)

Imagine a very common scenario where a corporate officer or employee steals valuable corporate data, deletes or compromises electronic information on his way out the door, solicits customers to leave prior to his termination of employment...and then says his employer must pay for the legal defense of is almost certain to be contentious litigation.

Is this such a far-fetched scenario?

Not really, and it all has to do with the concept of advancement and indemnification. Corporate laws across the United States provide that companies may indemnify officers, directors and employees for litigation costs and judgments incurred due to the fact of their affiliation with the company.

Advancement is a little bit different but related - it concerns the right receive legal fees prior to the time litigation is terminated and decided. In essence, it means the right to have someone else pay your attorney on a regular basis.

In many corporations, the rights to advancement and indemnification are mandatory under governing bylaws. This seems counterintuitive, but is used to attract key personnel as corporate officers and directors. An employee may even have such rights spelled out in an employment agreement.

Most of us are familiar with corporate executives being indemnified in breach of fiduciary duty cases, such as shareholder derivative actions, or even criminal suits for insider trading. But the same concepts apply in unfair competition law. Believe it or not, there are cases holding that a corporation suing a departed executive must advance legal expenses to that executive during trade secrets or fiduciary duty litigation - theories which fit the facts described in the first paragraph of this post. The reason is that advancement rights - particularly under Delaware law - are broadly interpreted.

As one court interpreting Delaware law recently stated: "The line between actions taken in a personal vis-a-vis corporate capacity is not drawn according to whether the director or officer acted detrimentally to the interest of the corporation, but instead on whether there is a nexus or causal connection between any of the underlying proceedings and one's corporate capacity without regard to one's motivation for engaging in that conduct."

In the context of trade secrets theft, an employee can claim that such conduct occurred as a result of his prior employment and that it arises directly out of his rule as a corporate fiduciary. Can the same be said of a non-compete violation? Probably not. The courts clearly hold that contractual obligations in a non-compete agreement are the product of an arms-length transaction, entered into by the employee in his personal - not corporate - capacity.

The lesson for counsel is this: don't forget about advancement and indemnity rights. The source of those rights is the governing state's corporation or limited liability company law, the bylaws or operating agreement, and any agreement the employee may have signed during his or her employment.

If the employee has advancement rights which are contested, then a court must decide those rights in a summary proceeding. The rights to advancement may be conditioned, however, on an employee's undertaking to repay such costs and fees to the corporation if his actions were not taken in good faith (or whatever the bylaws say on this). For a defendant who is in a precarious spot but wants to fight until the end, advancement only gets him or her so far. It is effectively an interest-free loan.

At the very least, though, it may give the company suing the ex-employee a strong incentive to work out an early resolution to the case.


Court: United States District Court for the Eastern District of Virginia
Opinion Date: 12/8/09
Cite: James River Mgmt. Co., Inc. v. Kehoe, 674 F. Supp. 2d 745 (E.D. Va. 2009)
Favors: Employee
Law: Delaware

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