Based on the Operating Agreement at Issue, Court of Chancery Denies Plaintiff Co-Trustee’s Advancement and Indemnification Claim

Delaware Fiduciary Litigation Blog

Posted March 10, 2014

Charles B. Grace, Jr., v. Ashbridge LLC, a Delaware limited liability company, C.A. No. 8348-VCN (December 31, 2013)

Charles B. Grace, Jr. (the “Plaintiff”) is one of several co-trustees of a family trust (the “Residuary Trust”). The Residuary Trust included cash, real property, and preferred and common shares of the family-owned investment company, Ashbridge LLC (the “Defendant”).

The Plaintiff is a member of Defendant and was a shareholder of its predecessor, Ashbridge Corporation, before its merger into Defendant. The Plaintiff also serves on the Board of Managers and as chairman of Defendant.

The trustees of the Residuary Trust filed two accountings to which its beneficiaries (the “Beneficiary Objectors”), filed objections on September 4, 2012 (the “Objections”) in the Court of Common Pleas of Chester County, Pennsylvania, Orphans' Court Division (the “Orphans' Court Proceeding”). The Objections asserted that the trustees breached their fiduciary duty in approving the formation and operation of Ashbridge Investment Management, LLC (“AIM”), an affiliate of Defendant. They further objected to the diminution in value of the trust's ownership interest in Ashbridge Corporation. And, they objected to BNY Mellon's fees and commissions in the amount of $154,826.99 in regard to BNY Mellon's breaches of fiduciary duty concerning the trustees’ imprudent investments, improper loans and reckless and wanton self-dealing transactions.

On June 8, 2011, before the Objections were filed, the Plaintiff sought reimbursement of expenses from the Defendant, without explaining why. The Defendant’s board of directors (the “Board”) refused to reimburse Plaintiff. Plaintiff, again, in November of 2012 requested advancement and indemnification. On December 6, 2012, the Board's counsel advised the Board that it was not obligated to authorize advancement and indemnification to the Plaintiff. At the December 19, 2012 meeting of the Board, it declined to consider the Plaintiff’s request for advancement and indemnification.

On February 22, 2013, the Plaintiff filed a complaint in the Delaware Court of Chancery seeking advancement and indemnification under Ashbridge LLC's operating agreement. In response, the Defendant sought a more definite statement which might clarify the theory under which the Plaintiff claimed his entitlement to advancement and indemnification. The Plaintiff filed a Verified Amended Complaint on April 12, 2013 (the “Amended Complaint”) and on that same day provided a hand-delivered undertaking for expenses in the Orphans' Court Proceeding, this current action, a failed mediation, and any other litigation claims asserted against the him by the Beneficiary Objectors. Defendant moved to dismiss the Amended Complaint for failure to state a claim upon which relief can be granted.

The Plaintiff argued that he was entitled to advancement and indemnification under Section 10.4 of Defendant’s operating agreement for attorneys' fees and other costs in this Delaware action and in the Orphans' Court Proceeding. He further argued that he was entitled to indemnification for other expenses in a mediation that was ordered in the Orphans' Court Proceeding and that his “substantive rights” to advancement and indemnification were supported by the bylaws of Ashbridge Corporation.

The Defendant argued that the Plaintiff failed to state a claim for advancement or indemnification because he was made a party to the Orphans' Court Proceeding “by reason of the fact” that he is a co-trustee of the Residuary Trust and that Defendant's operating agreement does not extend advancement or indemnification rights to predecessor entities or affiliates. The Defendant further argued that the Plaintiff cannot seek indemnification or advancement for certain actions taken in his “personal,” as opposed to his “official,” capacity and that certain expenses he claimed have not been identified or described in the Amended Complaint.

The Court held, after evaluating Section 10.4 of the Defendant's operating agreement, that Section 10.4 did not require indemnification for the Orphans' Court Proceeding because the Plaintiff requested advancement and indemnification for acts taken on behalf of predecessor and affiliate organizations, rather than for acts taken on behalf of Ashbridge LLC. The Plaintiff had to demonstrate that the Defendant's advancement and indemnification provision retroactively applied to predecessor entities or affiliates in order to prevail on his claims under Defendant's operating agreement. The operating agreement defined “the Company” to encompass only Ashbridge LLC. The Objections for which the Plaintiff claimed he was entitled to advancement and indemnification did not mention Ashbridge LLC, but instead asserted the various acts of mismanagement related to Ashbridge Corporation and AIM.

The Court further held that, the case law supported the outcome, because successor corporate entities are generally not liable for the actions of the corporate officers of predecessor entities or affiliates, when a fundamental change in identity has occurred. And Delaware law considers a conversion from a limited liability company to a corporation to be a “fundamental change in identity.”

The Court also reaffirmed that Delaware law allows entities to limit the scope of advancement and indemnification rights. Here, the Plaintiff’s argument failed because he only described the state of the law if an entity does not tailor its advancement or indemnification provision. He did not explain how Section 10.4 entitles him to a remedy when Defendant's operating agreement is narrower than the outer boundaries of the law. The Court further held that the Plaintiff could not recover for the costs incurred in pursuing the Chancery action.

Author(s)

Phillip Giordano
Associate
Gordon, Fournaris & Mammarella, P.A.