A little over a year ago, in the Ficus Investments case, the Manhattan-based Appellate Division, First Department, looked to Delaware case law for guidance in holding that an LLC manager named as defendant in an action brought by a member alleging conversion and fiduciary breach was entitled to advancement of his legal defense costs notwithstanding preliminary injunction rulings against him. (Read my prior post on Ficus here.)
Last month, in 546-552 West 146th Street LLC v. Arfa, 70 AD3d 512, 2010 NY Slip Op 01416 (1st Dept Feb. 18, 2010), the First Department again looked to Delaware precedent in another ruling of apparent first impression involving indemnification rights in the LLC internal warfare context. The issue this time: Is the defendant LLC manager entitled to indemnification for winning the non-merits dismissal of Action No. 1 prior to the adjudication on the merits of Action No. 2 asserting the same or similar claims? The Delaware Chancery Court answered “yes”, and now so too does the First Department.
The Arfa litigation saga begins in 2006, when several real estate holding LLCs sued their former managers for failing to make certain disclosures to the LLC members when they were being solicited to invest in the LLCs. In February 2007, Manhattan Commercial Division Justice Charles E. Ramos dismissed the case on the ground that the LLCs lacked standing to pursue the claims, which properly belonged to their members. In September 2008, the First Department rejected the LLCs’ appeal in a decision reported at 54 AD3d 543 (1st Dept 2008).
Meanwhile, even before the appeal was decided, the law firm that initiated the first suit on behalf of the LLCs started a second lawsuit on behalf of the members asserting the same claims against the managers. The second case remains pending.
Shortly after the First Department’s affirmance, the former managers moved for indemnification of the legal fees they incurred in the first action pursuant to §420 of the New York LLC Law and the LLCs’ operating agreements whose indemnification provisions tracked the statute.
In a ruling made from the bench on November 24, 2008 (read transcript here), Justice Ramos agreed that the former managers had satisfied the statutory and contractual requirements for indemnification, given that they had successfully moved to dismiss the LLCs’ claims on the pleadings. But he denied the motion without prejduce on the ground that it was not ripe. Specifically, Justice Ramos ruled that, until the pending lawsuit against the former managers by the LLCs’ members was resolved, he could not decide whether the former managers were entitled to indemnification with respect to the dismissed action brought by the LLCs. In other words, if the former managers were found to have engaged in wrongoing in the pending litigation brought by the LLCs’ members, the former managers would not be entitled to indemnification for the fees they incurred in successfully dismissing the LLCs’ lawsuit.
Last month, the First Department issued a decision reversing Justice Ramos and ordering that the former managers’ indemnification motion be granted. According to the court:
That claims for the same alleged wrongdoing remain pending in a parallel action brought by the investors does not impair defendants’ entitlement to the indemnification they seek. We interpret the indemnification provision (§6.8) in the LLC operating agreements, that substantially tracks the statute authorizing payment of expenses to managers regarding “any and all claims and demands whatsoever” (Limited Liability Company Law § 420), to require indemnification upon the resolution of the action or proceeding for which indemnification is sought. To make defendants wait until all of the related claims against them are resolved would eviscerate the right to indemnification . . .. The award of indemnification need not await a finding that defendants were free of misconduct. [Citations omitted.]
In deciding this issue of first impression, the First Department cited the Delaware Chancery Court’s decision in Stockman v. Heartland Industry Partners, L.P., 2009 WL 2096213 (Del. Ch. Ct. July 14, 2009). There, the former fiduciaries of a limited partnership sought indemnification of their legal fees from the limited partnership after a federal criminal proceeding against them was dismissed without prejudice prior to a trial on the merits. The limited partnership refused to indemnify them, arguing that the request was premature, i.e., the former fiduciaries’ eligibility for indemnification was dependent on the outcome of the civil action challenging their standard of conduct. Vice Chancellor Strine’s decision for the Chancery Court rejected this argument and held that the former fiduciaries did not have to wait until the related pending civil litigation against them had been resolved in their favor before the limited partnership had to indemnify them for the fees they incurred in the already dismissed criminal action. “To do otherwise,” VC Strine wrote, “would be the same as requiring indemnitees to wait for all proceedings against them arising from the same set of operative facts to be concluded before receiving indemnification for any of them, which this court has held to be improper in similar circumstances.” Id. at *11.
The Stockman decision in turn relied on prior Chancery Court decisions involving indemnification of corporate directors in Levy v. Hayes Lemmerz International, Inc., 2006 WL 985361 (Del. Ch. Ct. Apr. 5, 2006) (indemnification for settled class action granted prior to resolution of related SEC investigation), and Zaman v. Amedo Holdings, Inc., 2008 WL 2168397 (Del. Ch. Ct. May 23, 2008) (indemnification for non-merits dismissal of federal civil action granted prior to resolution of related state court action), where the courts emphasized the important role of indemnification in securing qualified persons to serve on corporate boards.
As I’ve noted before, advancement and indemnification of litigation expenses in disputes between company co-owners and managers can decisively tilt the playing field, whether it’s because the party seeking reimbursement cannot afford legal counsel otherwise, and/or because the indemnifying party is compelled to foot the adversary’s legal expenses as well as his or her own expenses. The First Department’s Arfa decision gives a boost to defendants seeking indemnification in the not infrequent scenario involving multiple, related litigations.
Update August 7, 2012: The First Department today handed down a decision (read here) rejecting the former managers’ bid to also recover their legal fees pursuing their right to indemnification, or what’s known as “fees on fees.” What’s interesting is that the court’s majority declined to follow Delaware case law’s more liberal approach in holding that the operating agreement’s indemnification provision must explicitly authorize fees on fees.