Fees on Fees for Corporate Indemnification: Who pays the bill when you have to sue your company to defend you?

As it appeared in the New Jersey Law Journal.

Schwartz, A.By Adam Schwartz, Esq.

So you are an officer or director of a company and you have been sued for some action (or inaction) you took in your corporate capacity. Does the company defend and indemnify you? In most instances, unless you are being sued for fraud, the company’s bylaws, and in some instances even New Jersey statutes, require the company to provide defense and indemnification. But what happens if the company refuses?

Under New Jersey’s corporate indemnification statute, you can sue to obtain the defense and indemnification to which you are entitled, but at what cost? Will you spend more suing the company than paying for your own defense in the underlying matter? Unless you can recover the attorney fees you incur in suing the company (often referred to as “fees on fees”), you will not be made whole. Moreover, if the company is not compelled to pay your legal fees, it creates an incentive to deny coverage in the first instance. Maybe you won’t bother suing. Maybe you won’t realize you can challenge the company’s decision to deny coverage.

There are no reported New Jersey cases addressing “fees on fees” in the corporate indemnification context. However, a New Jersey court will inevitably face this issue. How will it be resolved? On issues of first impression, New Jersey courts often look to other jurisdictions for guidance, such as Delaware and New York, which have similar corporate indemnification statutes. However, those states have reached opposite conclusions—Delaware allows an officer to recover “fees on fees” while New York does not. Thus, New Jersey courts facing this issue will likely follow the state—Delaware or New York—with the most persuasive reasoning.

As an initial matter, all three states follow what is called the “American Rule,” which provides that each litigant must bear his own legal costs unless a statute, court rule or contract specifically provides that a successful plaintiff can recover attorney fees. See Porreca v. City of Mellville, 419 N.J. Super. 212, 224 (App. Div. 2010); see also Goodrich v. E.F. Hutton Group, 681 A.2d 1039, 1043 (Del. Sup. Ct. 1996); Baker v. Health Management Systems, 98 N.Y. 2d 80, 88 (2002). Thus, the ability to recover “fees on fees” will be determined by corporate indemnification statutes and/or the company’s bylaws. As bylaws frequently provide for coverage “to the fullest extent” allowed under the law, the corporate statutes will be the focal point for any analysis.

The applicable Delaware Statute, 8 Del. C. 145(a), provides as follows:

A corporation shall have the power to indemnify any person who was or is a party or is threatened to be made a party to any … suit or proceeding … by reason of the fact that the person is or was a director, officer, employee or agent of the corporation … against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonablyincurred by the person in connection with such action, suit or proceeding.

In Stifel Fin. Corp. v. Cochran, 809 AD.2d 555 (Del. Sup. Ct. 2003), the Delaware Supreme Court noted that § 145(a) permits indemnification “in any action,” may extend to the indemnification action itself. It further noted that § 145(a) is remedial in nature and “should be broadly interpreted to further the goals it was enacted to achieve.” Those goals include (i) assisting corporate officials resist what they consider to be unjustified suits, and (ii) encouraging “capable men to serve as corporate directors, secure in the knowledge that expenses incurred by them in upholding their honesty and integrity as directors will be borne by the corporation they serve.”

In light of those objectives, the Stifel court held that “without an award of attorneys’ fees for the indemnification suit itself, indemnification would be incomplete.” Thus, it concluded that, while § 145(a) does not expressly state that “fees on fees” are recoverable, the language provides that “fees on fees” are “permissible” and therefore “authorized”—although not required. As the company’s bylaws provided for indemnification to the fullest extent of the law, and “fees on fees” are permissible under the law, the officer was reimbursed for the fees he incurred in seeking indemnification. Moreover, the Stifel court observed that allowing “fees on fees” under these circumstances would prevent a company with “deep pockets” from wearing down a former director, “with a valid claim to indemnification, through expensive litigation.”

In essence, Stifel subordinated the American Rule and looked to the purposes behind § 145(a) to determine that “fees on fees” supported the statute’s remedial purpose. It did not believe corporations would be unduly punished by this result because they can tailor their bylaws to exclude “fees on fees” if so desired.

On the other hand, New York’s highest court has held that New York’s corporate indemnification statute does not permit “fees on fees.” Baker, 98 N.Y.2d at 88. The corporate indemnification statute in New York, McKinney’s Business Corporation Law § 722, provides that:

A corporation may indemnify any person made, or threatened to be made, a party to an action or proceeding … by reason of the fact that he … was a director or officer of the corporation … against judgments, fines, amounts paid in settlement and reasonable expenses, including attorneys’ fees actually and necessarily incurred as a result of such action or proceeding, or any appeal therein.

In Baker, a corporate officer who successfully obtained indemnification argued that he was entitled to “fees on fees” because the attorney fees he incurred by suing to obtain indemnification were “necessarily incurred as a result” of his being sued in his corporate capacity for securities fraud. The Baker court rejected the officer’s argument, holding that the fees he incurred in the indemnification lawsuit were caused by the company’s refusal to indemnify; they were not incurred as a result of the officer being sued in the underlying securities fraud action.

The Baker court then examined the legislative history of §722 and discerned no evidence suggesting an intention to allow “fees on fees.” It further held that even if the officer’s argument had merit, it would be preempted by the American Rule. In essence, the Baker court held that, since “fees on fees” were not expressly authorized in §722, they are not available. It did not believe its holding would unduly punish corporate officers because they “remain free to provide indemnification of fees on fees in bylaws, employment contracts or through insurance.”

New Jersey’s corporate indemnification statute provides that: “Any corporation … shall have the power to indemnify a corporate agent against his expenses and liabilities in connection with any proceeding involving the corporate agent.” N.J.S.A. 14A:3-5(2). As with the Delaware and New York statutes, it is silent on the issue of fees on fees. The reasoning of Delaware and New York, provide credible arguments for and against “fees on fees.” However, New Jersey is more likely to follow the logic of Stifel.

The New Jersey Supreme Court has noted that Delaware’s corporate indemnification statute is similar to and in fact, constitutes “the very genesis of New Jersey’s Indemnification Statute.” Vergopia v. Shaker, 191 N.J. 217, 220, fn. 1 (2007). Thus, it will likely look to Delaware courts for guidance as it has previously done for corporate law issues. Moreover, New Jersey courts have recognized the remedial nature of the corporate indemnification statute and the goals it seeks to achieve—goals identical to those identified in Stifel. SeeCohn v. Southbridge Park, 369 N.J. Super. 156, 160 (App. Div. 2004) (noting that the statute (i) helps corporate officials resist what they consider to be unjustified suits and claims, and (ii) encouragescapablemen to serve as corporate directors.)

Moreover, one of the primary differences between New York and Delaware is who the courts believe are responsible for protecting themselves against an unfavorable result. Delaware believes that it is incumbent upon the company to amend its bylaws to exclude “fees on fees”; while New York places that burden for ensuring the availability of “fees on fees” on the individual officer.

Faced with this dichotomy, New Jersey will likely place the burden on the company to exclude coverage. In other instances, New Jersey courts have looked to the relative bargaining power of the respective parties to determine the viability of a claim. SeeMohammed v. Count Bank of Rehoboth Beach, Delaware, 189 N.J. 1, 15 (2006) (contracts of adhesion); see also Alloway v. General Marine Industries, 149 N.J. 620, 628 (1997) (whether tort or contract principles apply to transaction). In this instance, the relative bargaining power clearly rests with the company, which has already approved the bylaws and has deeper pockets that the individual.

Thus, notwithstanding New Jersey’s adherence to the American Rule, a New Jersey court will likely find that “fees on fees” are permitted under N.J.S.A. 14A:3-5(2).•

Reprinted with permission from the February 9, 2015 issue of The New Jersey Law Journal. © 2014 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

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