California and Delaware share many of the same rules when it comes to corporations, but they also diverge on some issues. When it comes to advancement of litigation expenses for officers and directors, California and Delaware are both remarkably similar and, at the same time, worlds apart.
Typically, corporations will indemnify their directors and officers who have acted in good faith against the costs of defending lawsuits arising out of their duties. Since indemnification rights usually cannot be established at the outset of the case, corporations will often agree to pay a defendant’s legal expenses in advance of a final judgment. Advancement is an especially important corollary to indemnification as an inducement for attracting capable individuals into corporate service. Advancement provides corporate officials with immediate interim relief from the personal out-of-pocket financial burden of paying the significant on-going expenses inevitably involved with investigations and legal proceedings.
Like Delaware, California provides that “expenses incurred in defending any proceeding may be advanced by the corporation prior to the final disposition of the proceeding.” (Corp. Code, § 317, subd. (f).) How a corporation chooses to provide advancement is left to the discretion of the shareholders and the board of directors. In many cases, the corporation will provide advancement rights in the by-laws.
Not surprisingly, disputes often arise as to whether (and when) a defendant has a right to advancement. That, in and of itself, is hardly unusual. Disputes regarding the interpretation of corporate bylaws are commonplace. But unlike ordinary disputes, advancement is not an issue that can wait for final judgment after trial, i.e. if a defendant is forced to pay for his own litigation expenses until the end of trial, his advancement rights will be defeated regardless of the judgment. Similarly, if the defendant officers use corporate money to pay their defense costs when no right of advancement has been approved, the corporation could suffer substantial losses if it lacks a remedy to stop the unauthorized advancement prior to trial.
This is where Delaware and California diverge. Unlike California, Delaware provides a specific summary proceeding to determine a defendant’s advancement rights.
The Court of Chancery is hereby vested with exclusive jurisdiction to hear and determine all actions for advancement of expenses or indemnification brought under this section or under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. The Court of Chancery may summarily determine a corporation’s obligation to advance expenses (including attorneys’ fees).
Del.Code Ann. tit. 8, § 145(k).
California, unfortunately, provides no specific remedy to enforce advancement rights. In the absence of a summary proceeding, injunctive relief is one option. Courts have granted preliminary injunctive relief to stop a director’s unauthorized or unlawful use of corporate funds to pay personal litigation costs. (Havens v. Attar (Del. Ch. Jan. 30, 1997) 22 Del. J. Corp. L. 1230, 1254-1258, No. 15134, 1997 Del. Ch. LEXIS 12 [enjoining advancement approved in breach of directors’ fiduciary duties before Delaware statutes provided a summary proceeding]; Johnson v. Couturier (9th Cir. 2009) 572 F.3d 1067, 1078-1081 [enjoining corporation from advancing defense costs to corporate directors accused of breaching ERISA fiduciary duties]; Allergia, Inc. v. Bouboulis (S.D.Cal. Jan. 19, 2017) Case No. 14-CV-1566 JLS (RBB) [advancement denied where by-laws incorporated limitations from indemnity clause].) Although injunctive relief is available, it does have its drawbacks. For example, the party requesting an injunction often needs to establish a risk of irreparable harm, which can be difficult on a simple motion hearing. A clear procedural remedy for challenging improper advancement would remove much of the uncertainty and ambiguity inherent in the current law.
