Under Section 145 of the Delaware General Corporation Law (“DGCL”), claims for indemnification or advancement by a director or officer of a corporation must relate to lawsuits or proceedings “by reason of the fact” that such person was or is serving in such capacity.  The recent decision of Lieberman v. Electrolytic Ozone, Inc., C.A. No. 10152-VCN (Del. Ch. Sept. 5, 2015) sheds light on the “by reason of the fact” standard, and qualifies as a relatively rare finding that the claims for which advancement is sought do not qualify under the statutory standard.

[We previously wrote about the recent Lieberman decision in this prior post to discuss the Court’s decision not to grant “fees on fees” in favor of plaintiff given his lack of success in obtaining advancement, despite language in the governing documents allowing for a recovery of attorneys’ fees so long as the claim is not found to have been brought in bad faith.]

In Lieberman, former directors of Electrolyte Ozone, Inc. (“EOI”), Wayne Lieberman and Carl Lutz, sought advancement arising from third party claims brought by EOI against plaintiffs in an arbitration proceeding between EOI and plaintiffs’ current employer, Franke Foodservice Systems, Inc. (“Franke”).  The arbitration between EOI and Franke arose from EOI’s early termination of a contract whereby EOI provided Franke with product and an exclusive license to intellectual property.  Franke alleged breach of contract claims, and EOI brought counterclaims against Franke and third-party claims against Lierberman and Lutz in connection with their respective At-Will Employment, Proprietary Information, Invention Assignment and Non-Solicit and Non-Compete Agreement (the “PIIA Agreements”) entered into by plaintiffs with EOI while employed therewith.

The Court analyzed whether the claims against plaintiffs were brought “by reason of the fact” that plaintiffs were former directors of EOI.  The Court noted that “the ‘by reason of the fact’ test requires ‘a nexus or causal connection between any of the underlying proceedings . . . and [Plaintiffs’] official corporate capacit[ies].’”  Homestore, Inc. v. Tafeen, 888 A.2d 204, 214 (Del. 2005).

The Court found that EOI’s arbitration claims on their face did not exist “by reason of the fact” that plaintiffs were former directors of EOI, because the arbitration claims were derived from specific contractual obligations, which Plaintiffs allegedly breached post-termination.  The arbitration claims among other things alleged breach of contract under the PIIA Agreements, for failing to return EOI property and proprietary information, and for failing to comply with post-termination obligations.

The Court held that the claims brought by EOI for misuse stemmed from plaintiff’s post-termination conduct, and “do not depend on Plaintiffs’ use of corporate authority or position.”  In this regard, the Court provided:

Importantly, the claims it did bring could not merely be relabeled as claims that would warrant advancement. EOI could succeed on all of its claims based on a set of facts that would not support a finding of a fiduciary breach or an abuse of a corporate position. That EOI might theoretically have been able to bring other distinct claims does not justify advancement. Plaintiffs’ conduct as EOI officers, directors, or employees is essentially immaterial to EOI’s contractually-based Arbitration claims. Because those claims arise solely from alleged post-termination breaches of personal obligations under the PIIA Agreements, Plaintiffs are not entitled to advancement.

Accordingly, the Court rejected plaintiffs’ claims for advancement because EOI’s arbitration claims did not arise “by reason of the fact” that plaintiffs were former directors of EOI.

If you would like to speak to a litigator in Fox Rothschild’s Delaware office, please reach out to Sid Liebesman (302) 622-4237 or Seth Niederman (302) 622-4238.