Filed: May 21, 2012
Opinion by Judge W. Michel Pierson
Held: In an order denying motion for reconsideration, the Court held that Plaintiffs (directors of Defendant corporation) were not entitled to advancement of reimbursement of legal fees and expenses that Plaintiffs incurred in connection with their defense against a counterclaim filed by Defendants. The Court concluded that Plaintiffs could not affirm in good faith that the standard of conduct necessary of indemnification of legal expenses had been met.
Facts: Plaintiffs were members of an LLC that owned preferred stock in the Defendant corporation. Plaintiffs believed Defendant corporation wrongfully failed to pay dividends on the preferred stock. Plaintiffs became members of the Board of Directors of Defendant corporation in hopes of changing accounting methods that calculate preferred dividend payment requirements. Plaintiffs filed suit against Defendant corporation to require Defendant corporation to produce accounting documents and records necessary for Plaintiffs to perform their duties as directors. Plaintiffs also sent letters to the public accounting firm engaged to perform the annual audit of Defendant corporation's financial statements. The public accounting firm subsequently resigned from the audit citing a conflict of interest because members of the board of directors were not allowed to contact or influence the auditors. Defendant corporation then filed a counterclaim against Plaintiffs for tortious interference with the contractual relations between Defendant corporation and its auditors and breach of fiduciary duty by Plaintiffs.
Plaintiffs filed a motion seeking an order requiring Defendant corporation to advance reimbursement of legal fees and expenses that Plaintiffs incurred in connection with their defense against the counterclaim. The motion was denied. Plaintiffs then filed a motion for reconsideration.
Analysis: Maryland law allows for the indemnification of legal expenses of officers and directors who are sued by reason of their service. Maryland law also allows for the advancement of legal fees pending the outcome of the final proceeding. In order for a director to receive advancement of legal fees pending the final outcome, the director must: 1) make a written affirmation to the corporation of the director's good faith belief that the standard of conduct necessary for indemnification by the corporation has been met, and 2) provide the corporation a written undertaking by or on behalf of the director to repay the amount if it is ultimately determined that the standard of conduct has not been met.
The standard of conduct required is set forth in Maryland statute section 2-418(b)(1), which provides that a corporation may indemnify a director unless it is established that the act or omission of the director was material to the matter giving rise to the proceeding, and was committed in bad faith, or was the result of active and deliberate dishonesty, or the director actually received an improper benefit in money, property, or services.
The Court held that an affirmation of good faith is usually accepted as sufficient to show the directors believed their conduct met the standard, and that there should not be an overly intrusive examination into whether an affirmation was made in good faith. However, the Court held that some review of the affirmation is permitted. The Court ruled that the affirmation may be deemed invalid in situations where the record, objectively viewed, makes the maintenance of a good faith belief untenable. Here the Court concluded that Plaintiffs were not entitled to an order of advancement because the facts on the record showed that Plaintiffs could not affirm in good faith that the standard of conduct necessary for indemnification of legal expenses had been met.
The full opinion is available in PDF.
The denial of motion for reconsideration is available in PDF.