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Corporation Is Required to Advance Legal Fees To Corporate Director to Defend Lawsuit

Unless Articles of Incorporation Expressly Exclude Such Advances

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2011-0024.  Miller v. Miller, Slip Opinion No. 2012-Ohio-2928.
Trumbull App. No. 2009-T-0061, 190 Ohio App.3d 458, 2010-Ohio-5662. Judgment reversed and cause remanded.
O’Connor, C.J., Pfeifer, Lundberg Stratton, Lanzinger, Cupp, and McGee Brown, JJ., concur.
O’Donnell, J., dissents.
Opinion: http://www.supremecourt.ohio.gov/rod/docs/pdf/0/2012/2012-Ohio-2928.pdf

Video clip View oral argument video of this case.

(July 3, 2012) The Supreme Court of Ohio ruled today that a corporation cannot avoid its duty under R.C. 1701.13(E)(5)(a) to advance the legal defense expenses of a corporate director who is sued in his or her capacity as a director by claiming that the director’s misconduct, if proven, would amount to a violation of his or her fiduciary duties to the corporation.

The court held further that when a director has submitted to the corporation a written undertaking (document) seeking an advance of legal expenses that meets the requirements of R.C. 1701.13(E)(5)(a), the corporation must provide the requested advance unless its articles of incorporation or regulations specifically state that R.C. 1701.13(E) does not apply to the corporation.

Applying those holdings to a Trumbull County case, the court ruled that Sam M. Miller, a director and co-owner of Trumbull Industries Inc., an Ohio corporation that sells plumbing supplies, was entitled to an advancement of his legal expenses from the corporation. Sam M. Miller had requested the  advancement to cover the costs of defending a lawsuit filed against him by two other directors of the corporation, Murray Miller and Sam H. Miller, for allegedly violating his fiduciary duties to them as shareholders and to the corporation itself.

The court’s 6-1 majority decision was authored by Chief Justice Maureen O’Connor.

In December 2002, Sam M. sent a memorandum to Murray and Sam H. informing them about a  business opportunity called the Brand Company Project. The proposed new company would market private-brand plumbing products for sale to manufacturers including Jacuzzi, Inc., and possibly to other wholesalers. Murray and Sam H. objected to Sam M.’s involvement in the new venture, and demanded that he cease and desist.

When Sam M. did not comply with those demands, Murray and Sam H. filed suit against him and other participants in the Brand Company Project in the Trumbull County Court of Common Pleas. Their complaint sought injunctive relief and damages, alleging that Sam M.’s involvement in the Brand Company Project was in violation of his fiduciary duties to them as shareholders of Trumbull Industries, and to the corporation itself.

Sam. M. subsequently sent a memorandum to Murray and Sam H. notifying them that he had reimbursed himself from Trumbull Industries’ corporate funds for the costs he had incurred in preparing a defense against their lawsuit. In support of his right to that advancement, he attached a copy of an “undertaking” he had executed “pursuant to R.C. 1701.13(E)(5)(a).” That document requested that the corporation advance him funds to cover his legal defense costs, and incorporated language from the statute agreeing that Sam M.: 1) would pay back any advancements he received if it were found that his acts or omissions had been committed with a deliberate intent to injure, or with reckless disregard for the corporation’s best interests; and 2) would reasonably cooperate with the corporation in the lawsuit or proceeding for which he sought the advancement.

Both sides filed motions with the court seeking a declaratory judgment on the issue of whether Sam M. was entitled to indemnification of attorney fees by the corporation.  In January 2007, the trial court issued an opinion ordering Sam M. to reimburse Trumbull Industries for $240,068 of the $320,091 in legal fees that had been paid from corporate funds up to that time. The court based that holding on its “tentative” determination that because Sam M. was one of four defendants in the underlying lawsuit, only 25 percent of the legal fees that had been incurred were attributable to Sam M. as a corporate director, and therefore only 25 percent of the legal fees were subject to advancement by the corporation.

Sam M. filed a motion asking the trial court to reconsider and clarify its order, asserting that a review of the legal invoices that had been paid from corporate funds to date would show that 99 percent of those costs were attributable to the defense of Sam M. as a corporate director, and not to the other named defendants. Sam M. also argued that by filing the written undertaking required by R.C. 1701.13(E)(5)(a), he had already agreed to repay at the end of the litigation any advanced legal costs to which he was not entitled. The trial court denied the motion to reconsider.

Subsequently, both sides asked the trial court to clarify the impact of its January 2007 decision on the corporation’s ongoing obligation to advance Sam M. the costs of his legal defense. The court issued a new ruling in June 2008 in which it found that legal work performed by the firm of Ulmer and Berne beginning March 25, 2008 had been performed exclusively on behalf of Sam M. as a corporate director.  The court therefore ordered Trumbull Industries to advance Sam M. funds to cover his bills from Ulmer and Berne from March 25, 2008 forward. When the corporation failed to obey that order, Sam M. sought and received a finding by the trial court that Trumbull was in contempt. The trial court subsequently imposed a sanction against Trumbull of $5 per day for each day it failed to advance Sam M. funds to cover the legal services he received from Ulmer and Berne starting March 25, 2008.

The corporation, Murray, and Sam H. appealed the trial court’s finding of contempt, sanction, and order awarding Sam M. fee advancements. On review, the Eleventh District Court of Appeals reversed the trial court and held that Sam M. was not entitled to indemnification for his legal defense costs from Trumbull Industries. Sam M. sought and was granted Supreme Court review of the Eleventh District’s ruling.

In today’s decision, Chief Justice O’Connor wrote that in arriving at its ruling, the court of appeals had incorrectly relied on R.C. 1701.13(E)(1) and (E)(2), legal provisions that address the entitlement of a corporate director to indemnification for litigation expenses after legal claims against the director have been determined.  In this case, she wrote, Sam M.’s claims should have been considered only under R.C. 1701.13(E)(5)(a), which addresses the separate legal question of whether a corporation is obliged to make advance payments to cover a director’s legal defense costs while a lawsuit against the director is pending.

“The issue of whether Sam M. violated his fiduciary duties and, therefore, is not entitled to indemnification, is not appropriate for our review,” wrote Chief Justice O’Connor. “The only issue that is properly before this court now is whether Sam M. is entitled to advancement of expenses. Likewise, that is the only issue that should have been decided by the appellate court.”

“R.C. 1701.13(E)(5)(a) states that a director’s expenses ‘shall’ be paid by the corporation, evidencing an intent by the legislature to make advancement of a director’s expenses by a corporation to be mandatory. ... (A)dvancement was required only if Sam M. complied with the terms of R.C. 1701.13(E)(5)(a)(i) and (ii). It is undisputed that on September 13, 2005, Sam M. executed the requisite undertaking to comply with the terms of R.C. 1701.13(E)(5)(a) and that in that undertaking, Sam M. agreed to abide by the duties set forth in R.C. 1701.13(E)(5)(a)(i) and (ii).  It is also undisputed that appellees received Sam M.’s undertaking.” 

“Yet, appellees argue that Sam M.’s agreement to ‘reasonably cooperate’ with the corporation was ‘a sham.’  Appellees point to Sam M.’s deposition testimony as evidence that ‘he would not cooperate with Trumbull in this litigation unless ordered to do so by a majority of the Trumbull Board.’  The cited testimony does not support appellees’ argument. First, appellees fail to point to any specific evidence showing that Sam M. has actually failed to reasonably cooperate with the corporation.  Second, when, as here, a director is being sued by his corporation, any duty to ‘reasonably cooperate’ should not require the director to surrender his right to defend himself.”

Quoting from United States v. Stein, a 2006 decision of the U.S. District Court for the Southern District of New York, the Chief Justice wrote: “Even when the parties are at odds in litigation, the duty to advance expenses often ‘requires companies to advance the cost of defending claims that allege wrongs to the companies, even lawsuits brought by companies themselves against former officers and directors.’ ... Here, Sam M. executed the requisite undertaking described in R.C. 1701.13(E)(5)(a)(i) and (ii).  When appellees received the undertaking, their statutory duty to advance Sam M.’s expenses arose. Thus, appellees are required by statute to advance Sam M.’s expenses pursuant to R.C. 1701.13(E)(5)(a).”

“Based upon the unambiguous language of R.C. 1701.13(E)(5)(a), we hold that Trumbull is required by law to advance expenses to Sam M.  Trumbull’s articles of incorporation do not state by specific reference that R.C. 1701.13(E)(5)(a) does not apply to Trumbull.  Thus, we hold that appellees failed to show that Trumbull opted out of the mandatory advancement requirement.  Finally, we hold that Trumbull’s statutory duty to advance Sam M.’s fees arose upon receipt of Sam M.’s undertaking.   For these reasons, we reverse the appellate court’s judgment finding that the trial court improperly ordered Trumbull to pay the attorney fees of Sam M., reinstate the trial court’s judgment finding Trumbull in contempt for refusing to pay Sam M.’s expenses pursuant to R.C. 1701.13(E)(5)(a), and remand the cause to the trial court for further proceedings consistent with this opinion.”

Chief Justice O’Connor’s opinion was joined by Justices Paul E. Pfeifer, Evelyn Lundberg Stratton, Judith Ann Lanzinger, Robert R. Cupp and Yvette McGee Brown.

Justice Terrence O’Donnell dissented, stating that in his view the majority misconstrued the advancement statute. He wrote: “It does not apply in these kinds of circumstances where a corporation is suing one of its own directors. Notably, the defendant director has a duty to cooperate with the plaintiff corporation and cannot do so. To require advancement of expenses in this situation is unwarranted and fails to carry out legislative intent.”   

“The General Assembly ... did not intend to require a corporation suing one of its directors for fraud and for usurping a corporate opportunity to advance the costs of defending the action against itself.  When the director and the corporation are adverse parties in litigation, the director simply cannot reasonably cooperate in the manner required by the statute, and the circumstances of this case demonstrate the futility of expecting a director to fully and honestly assist the corporation’s suit against him.

“I would affirm the judgment of the court of appeals, and because the majority of the court fails to recognize the director’s duty to reasonably cooperate with the corporation concerning actions, suits, or proceedings, I urge the General Assembly to reexamine this statute and further clarify that when the corporation is suing the director and there can be no such cooperation, no fees need be advanced in such circumstances.”

Marvin L. Karp, 216.583.7014, for Sam M. Miller.

Irene Keyse-Walker, 216.592.5000, for Murray and Samuel H. Miller.