James River Management v. Kehoe: Advancement of Fees and Expenses

In James River Management v. Kehoe, No. 09-387, 2009 WL 4730715 (E.D. Va. Dec. 8, 2009), the District Court of the Eastern District of Virginia granted a motion for advancement of fees and expenses to defendant from a Delaware-chartered company and denied the same motion to defendants from the company’s Ohio-incorporated subsidiary. 

Plaintiff James River Group, Inc. (“JRG”) was a Delaware corporation and defendant Michael Kehoe was its sole director.  Plaintiff James River Insurance Company (“JRIC”) was incorporated in Ohio.  All defendants, Kinsale Management, Inc. and Kinsale Capital Group (“Kinsale”), William Kenney, Brian Haney, Ann Marie Marson, Edward Desch (“James River Individual Defendants”), Greg Share, and Michael Kehoe, were on JRIC’s board of directors, and all defendants sought advancement from JRIC.

Plaintiffs JRG and JRIC filed suit against defendants alleging misappropriation of trade secrets, breach of contract, and breach of fiduciary duty.  Plaintiffs claimed that defendants used their positions to form the knowledge and expertise to start a competing company. Defendants subsequently moved for an order requiring JRG and JRIC to advance all fees and expenses, including attorneys’ fees, incurred by defendants in connection with this litigation.

A corporation can make the right to advancement of expenses mandatory through either its certificate of incorporation or through its bylaws.  When this is the case, the recipient’s right is enforced as a contract.  A director’s right to advancement is not dependent upon the likelihood that he will ultimately be entitled to indemnification.  The two notions are distinct.  The right to advancement also does not depend on the likelihood of repayment if the litigant loses.

Section 145 of the Delaware Code provides that indemnification is available for actions brought against officers and directors, even if the defendant does not ultimately prevail.  Additionally, the statute provides that a corporation may "advance" fees and expenses in advance upon receipt of an undertaking by such director or officer to repay the corporation if the director or officer is ultimately not entitled to indemnification.  Advancement and indemnification rights, however, may only extend to legal proceedings incurred “by reason of the fact” of the director’s position as a director, and not resulting from activities that a director pursues in his personal capacity.  There needs to be a nexus or causal connection between the underlying proceedings and one’s official corporate capacity in order for those proceedings to be “by reason of the fact.”

 The JRG bylaws include mandatory advancement and indemnification provisions that state

[E]xpenses incurred by a present or former director, officer, employee, or agent… shall be paid by the corporation in advance of the final disposition of such action… upon receipt of an undertaking by or on behalf of the director or officer to repay the amount if it shall ultimately be determined that [the director or officer] is not entitled to be indemnified by the corporation.

The court found that nexus existed between the claims against Kehoe and his corporate capacity, thereby entitling him to the advancement of expenses.  The claim asserted that he used his “entrusted corporate powers” to misappropriate JRG’s trade secrets and form a competing company.  If Kehoe had any liability, it would rise directly out of his former position as a director of JRG, and thus would satisfy the requisite nexus between the proceedings and his official corporate capacity. 

With respect to advancement from JRIC, the issue turned on Ohio law.  Section 1701.13 of the Ohio Code contained language slightly different from Delaware.  Like the Delaware Code, the Ohio Code provides that a corporation may indemnify its management.  The Ohio Statute also states that “expenses incurred by a director in defending an action or proceeding shall be paid by the corporation as they are incurred, in advance of the final disposition of the action.”  As the court noted:

• One could interpret it, as the Defendants urge, to command a result that corporations must always advance fees and expenses any time a corporate officer or director is sued for acts with a nexus to his official capacity. Alternatively, one could view the right to advancement . . . as devolving from a decision . . . to indemnify, as the Plaintiffs argue. It is undisputed that JRIC did not provide advancement or indemnification rights to its officers in its bylaws.

The District Court held that the latter view was correct.  Reading the statute as a whole, the court concluded that the plain meaning of the statute indicated that the advancement provision devolved from the decision made under the indemnification provision.  Ohio corporations were not, therefore, always required to advance fees to its director-litigants, but rather only when the corporation had chosen to make indemnification available. 

Because JRIC did not opt in to the indemnification and advancement provisions under the Ohio Code, the defendants were not entitled to advancement for fees and expenses incurred while litigating the claims brought by JRIC.

The court held JRG must advance Kehoe’s expenses for its claims against him under the Delaware Code, but JRIC was not required to advance expenses to the defendants under the Ohio Code.

The primary materials in this case can be found at the DU Corporate Governance Web Site.