Gibson Dunn discusses Delaware Court of Chancery Opinion Clarifying Director and Officer Advancement Rights

On May 28, 2015, Chancellor Bouchard of the Delaware Court of Chancery issued an opinion clarifying and strengthening the rights of a former director and officer to receive mandatory advancement under a corporation’s charter. In Blankenship v. Alpha Appalachia Holdings, Inc., C.A. No. 10610-CB (Del. Ch. May 28, 2015), the Court held that, where a corporation has agreed to indemnify and advance defense costs to the fullest extent permitted by law, the corporation cannot later condition its advancement obligation on statements about an individual’s belief that he or she acted lawfully. Instead, the only condition for advancing defense costs for conduct is the provision of an undertaking by the director or officer to repay the advanced costs if the conduct later turns out not to be indemnifiable. This decision reaffirms the strong protection of director and officer indemnification and advancement rights under Delaware law, “which supports resolving ambiguity in favor of indemnification and advancement.”

Most public companies agree that they will advance defense costs to their directors and officers, subject to receipt of an undertaking to repay these costs if it is determined, at the conclusion of a proceeding, that an individual did not meet the standard of conduct for indemnification under Delaware law. To meet this standard, an individual must have acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the corporation’s best interests. In addition, in a criminal proceeding, the individual must have had no reasonable cause to believe his or her conduct was unlawful.

The Blankenship case concerned the right to indemnification and advancement by Donald Blankenship, the former CEO and Chairman of Massey Energy Company (“Massey”), a coal mining business. In April 2010, twenty-nine miners were killed in an explosion at one of Massey’s mines. In 2011, after Mr. Blankenship retired, Massey entered into a merger agreement with Alpha Natural Resources, Inc. (“Alpha”). After the merger, Massey sent a letter to Mr. Blankenship stating that Massey remained committed to providing “appropriate assistance with the legal defense” of its employees in connection with investigations into the 2010 explosion, and requesting that he sign a new undertaking (the “Undertaking”) that would clarify the relationship. The Undertaking stated that Massey’s advancement of expenses to Mr. Blankenship was contingent upon him making certain representations, including a representation that he “had no reasonable cause to believe that his conduct was ever unlawful.”

Alpha’s acquisition of Massey was completed in June 2011. Mr. Blankenship incurred legal expenses arising out of the government’s investigation of the 2010 mine explosion, which Massey paid. This investigation led to a 2014 criminal indictment being made against Mr. Blankenship. After the indictment, Massey and Alpha determined that Mr. Blankenship had breached his representation in the Undertaking and ceased advancing the costs of his defense.

The Court held that, while the Undertaking required Mr. Blankenship to make certain factual representations before advancement could begin, it could not provide a basis for Massey to terminate its obligations to advance his legal costs. Massey’s charter required Massey to advance costs to the maximum extent provided by Delaware law. The Court noted that when a Delaware corporation adopts charter provisions requiring broad, mandatory advancement, it cannot condition its advancement obligation on anything other than an undertaking to repay the expenses if it is later determined that indemnification is not available because an individual has not met the Delaware law standard of conduct. The representations in the Undertaking, such as Mr. Blankenship’s good faith and reasonable belief that his conduct was not unlawful, merely served to provide reassurance to Massey before it commenced advancing funds; they could not serve as a justification for terminating advancement while Mr. Blankenship was in the middle of his defense.

The Court also concluded that Alpha was responsible for continuing indemnification and advancement costs under standard provisions in its merger agreement with Massey requiring Alpha to cover such costs for claims arising after the merger. The Court concluded that the 2014 indictment of Mr. Blankenship constituted a new claim, for which Alpha had an indemnification and advancement obligation. Moreover, the Court rejected Alpha’s argument that it could impose terms and conditions on Blankenship’s right to advancement, such as requiring a representation (similar to that in the original Undertaking) about not having engaged in unlawful conduct. According to the Court, other than requiring an undertaking to repay, which Blankenship had provided after the merger, Alpha could not restrict his ability to receive advancement because there was no basis for doing so under the merger agreement and the relevant indemnification language.

This case serves as a useful reminder that the Delaware courts tend to be skeptical of arguments that a corporation may condition or limit director or officer rights to indemnification and advancement during the pendency of an indemnified party’s defense. Companies that wish to preserve discretion to limit these rights should draft their indemnification provisions accordingly and make this intent very explicit. If a corporation adopts broad mandatory indemnification and advancement obligations in its governing documents, which remains the predominant approach, Delaware courts will take a dim view of efforts to revoke or limit these crucial protections when they matter most. Likewise, an acquirer who agrees to provide such protections to its target’s former management will be held to its indemnification and advancement obligations it agreed to in a merger. Nonetheless, directors and officers should carefully review the terms of their indemnification rights, and should avoid entering into undertakings beyond the standard undertaking to repay funds advanced in the event that it is ultimately determined that indemnification is not appropriate.

The decision can be found here.

The full and original memorandum was published by Gibson Dunn on June 1, 2015 and is available here.