Long week getting my firm up and running, but things are coming together now and I will be back to blogging on a regular basis.

I read an interesting case today in which defense counsel in a securities class action tried to refuse to produce the defendants' Wells submissions to the SEC on the grounds that the submissions contained settlement offers. The Court did not buy it. As it correctly noted, Fed. R. Evid. 408 keeps settlement offers out of evidence at trial when offered to prove liability (or its absence) or the amount of a claim. Being inadmissible for certain purposes is not the same as being non-discoverable. Nice try though. See In re Initial Public Offering Securities Offering Litigation, 21 MC 92 (S.D.N.Y. December 24, 2003) (Scheindlin, J.).

Director and Officer Right to "Fees for Fees" Clarified in Recent Delaware Chancery Opinion

In Weaver v. ZeniMax Media, Inc., Del. Ch. Civ. A. No. 20439-NC, 2004 Del. Ch. Lexis 10 (January 30, 2004) (Noble, V. Ch.), the Chancery held that a former officer and director (together, "officer") was entitled to fees for fees (an award of his legal fees incurred in pursuing an action to order the corporation to advance legal fees to him) even though the Company's bylaws were not as pro-officer as they were in the Stifel Financial case, where the right to fees for fees was established.

The Chancery held that: "Under Stifel Financial, if a corporation does not want to incur the obligation to pay "fees on fees," it must expressly preclude any such right."

Weaver is also an interesting case because it parses out the officer's right to fees where he is pursuing an action against the company for claims that are not indemnifiable and the company counterclaims on bases that are partly indemnifiable. Weaver sued the company for severance benefits -- claims that are not indemnifiable, and the company counterclaimed for (1) wasting corporate assets; and (2) failure to do his job properly. Although both counterclaims were styled in terms of breach of fiduciary duty, the Chancery held that the second counterclaim was in the nature of an employment dispute and was accordingly not indemnifiable, but the first claim was involved abuse of corporate powers and was accordingly indemnifiable. (ZeniMax actually conceded in its brief that the latter were indemnifiable.)

The Chancery rejected a mechanical percentage approach to allocating Weaver's fees between indemnifiable and not indemnifiable and left it Weaver's attorneys to allocate fees in good faith.

I tracked down and read the decision discussed in the Wall Street journal, and in my February 18, 2004 -- Bergonzi v. Rite Aid Corp., Del. Ch. Docket No. Civ. A. 20453-NC (October 20, 2003) (Chandler, Ch.) -- the Westlaw cite is 2003 WL 22407303. To recap, the decision held that Rite Aid was obligated to advance legal expenses to a former officer who had pleaded guilty to fraud but had not yet been sentenced. The obvious problem here is that because he was pleading guilty to knowing wrongdoing, he was not entitled to indemnification at the end of the day. Any funds advanced to him would theoretically have to be repaid. It seems like a safe bet that the officer did not intend (or would not be able) to repay the funds once he was in prison for fraud.

The gist of the decision is that Rite Aid had made its own bed by drafting the advancement provisions in its Certificate of Incorporation in a manner that obligated it to advance the funds. Essentially, the Certificate required a "final disposition" of the underlying proceedings before the company was entitled to defend against the officer's claims on the grounds that he "had not met the standards of conduct which make it permissible under the General Corporation law for the corporation to indemnify [him]." The Chancery cited solid cases for the proposition that in a criminal proceeding, sentencing is the final judgment.

As the Chancellor explained, "Rite Aid could have easily drafted this provision differently, but it did not and must now maintain its bargain with its former officer."

I understand the Chancellor's reasoning, and holding a party to a bargain is certainly a core legal principal, but this still seems wrong. The former officer had "admitted under oath to deliberate falsification of the Company's financial statements and receiving a fraudulently back-dated employment agreement purporting to grant him millions of dollars." I just don't understand how the Chancellor could have refused to conclude that this guy was not entitled to advancement. Let's face it. In any complex factual and/or legal issue, there is room to come to a principled conclusion in the opposite direction.

The undertaking to repay that Rite Aid required the officer to sign in order to receive advancement promised to repay all sums advanced if a court of competent jurisdiction decided that the officer had failed to meet the standards of conduct required in order to qualify for indeminification. Seems to me that the Chancery was a court of competent jurisdiction and could have made such a finding.

I've nearly got my new firm situation squared away, and expect to be up and running for real again by Friday.

Yesterday, I was struck by an article in the WSJ about advancing costs to officers and directors when they get into legal trouble stemming from their service to a corporation -- one of the topics that interests me most. The article discussed some recent decisions by the Delaware Chancery court -- I have to read them and report back in greater detail, but according to the article, in one recent decision the chancery declared that a corporation was obligated to continue advancing legal expenses to an officer who had pleaded guilty to fraud and was awaiting sentencing. The Chancery apparently held that the officer had not been finally adjudicated guilty of fraud until the sentence was imposed. That strikes me as completely wrong.

The general structure under Delaware law is that an innocent officer or director (together, "officer") is entitled to have his or her legal expenses reimbursed by the corporation, but one who is guilty of fraud is not. In fact, the statute prohibits such reimbursement. Where it gets sticky is in connection with "advancement," or paying the expenses as they are incurred, when guilt or innocence remains an open question. Most companies advance expenses, and D&O policies provide for advancement as well. But once guilt has been determined, the officer is no longer entitled to advancement, or even indemnification, and so theoretically must pay the company back for all the expenses advanced. If the officer doesn't have the money, however, then the company is out of luck -- seems like this would be particularly likely when the officer is about to go to prison. I have to double check this point, but I doubt that an insurance company gets paid back even once guilt is determined and even if the officer has the money.

So when the officer has pleaded guilty but not yet been sentenced, I suppose at some technical level, a final judgment has not yet entered. But the guilt is clear, and the innocent company -- or other innocent officers, should not suffer. Think for example about the situation where the D&O policy has to advance big bucks to defend the crook. This depletes the policy and leaves less money to defend the innocent. Not the way we want things to work, I think.

Anyway, I'll do some more research and report back.

Well, I know the Dalai Lawyer has been a little quiet the past several days. My excuse? I'm opening my own firm with some friends. As of this coming Tuesday, February 17, 2004, I will be a partner in the firm Quigley, O'Connor & Carnathan, LLC. I've been pretty distracted recently.

More substantive postings will start rolling again soon. Check back.

Some brief thoughts on the importance of keeping your client's business in mind when litigating a case.

I think this is a weak suit for a lot of lawyers, even some that are considered big hitters and theoretically should be smart enough to know better. I was recently involved in a case where our opponents were bound and determined to pursue a litigation strategy that seems sure to bite their client on the behind by alienating a major business partner. It was a great mystery to me why they would do such a thing. Maybe there is more to the story than I know, but I doubt it. I would say that the lawyers were just so focused on their case that they lost sight of the big picture.

A big lawsuit can be critical to a company's health, to be sure, but the impact of a litigation strategy on the company's business has to be an explicitly considered factor in choosing a strategy. If you win the lawsuit but kill the company, you haven't done your client any good service.

Doh! A breathtaking example of why you should watch your mouth when talking to the press.

On January 30, 2004, the Eleventh Circuit issued an opinion in Grasta v. First Union Securities, Inc., Docket No. 02-16215. The gravamen the plaintiffs' claims is that First Union issued knowingly false "strong buy" recommendations for Ask Jeeves, complete with a target share price of $230 per share when the stock had fallen to just over $23, in order to get Ask Jeeves's investment banking work.

In support of their contention, the plaintiffs cited an article in Smart Money magazine in June 2000, quoting First Union's analyst as saying "I've got three different hats to wear. There's the research, but then there's the banking and marketing. I've got an obligation to all three . . . You have to pay the bills." Ouch. Talk about throwing yourself under the bus. Even after this acknowledgement, First Union kept issuing strong buy recommendations. I suppose you could argue that after this public acknowledgement that the research reports were tainted by self (conflicting) interest, the "truth had emerged" as they say in the securities fraud world. But the complaint was filed in April 2001, so the defendant needed to drive the date of notice to the plaintiffs back to at least a year plus a day earlier than that.

First Union prevailed on statute of limitations grounds before the District Court, based upon the court's conclusion that the plaintiffs were on inquiry notice of their potential claims when the price of the stock dropped to $24 more than on year before the complaint was filed (on an earlier day in April 2000). The alleged wrongdoing occured before the securities statute of limitations was extended to three years from notice/five years repose -- at the time, the statute required a suit to be filed within one year of notice. The court based its finding of inquiry notice solely on the drop in the stock price. The Eleventh Circuit reversed, holding that "[t]here may be numerous reasons, other than fraud, for a stock to decline (even steeply) in price."

The defendant noted almost a dozen articles published between May 1996 and June 2000 discussing the conflict of interest inherent in companies both issuing research reports and doing investment banking work. But the defendants could not, on a 12(b)(6) record, connect the named plaintiff to these articles to show prior notice of the conflict. The defendant also sought to rely on some disclosures in the reports themselves regarding the defendant's other business activities, but the Court found the disclosures too "general and ambiguous to provide a warning of the fraud alleged in the complaint: that the ratings, recommendations, and target prices in the reports were not based on [the analyst's] unbiased real opinions, but were instead deliberate attempts to inflate the stock price and thereby attract Ask Jeeves' investment banking business."

And to add insult to injury, First Union struck out and did not get the investment banking work when Ask Jeeves did a secondary offering. You can read the opinion here.

I just finished reading In re Ebay, Inc. Shareholders Litigation, Delaware Chancery Docket No. 19988-NC, 2004 Del. Ch. LEXIS 4 (January 23, 2004) (Chandler, Ch.). It's a fascinating case, not because the legal principles are all that complicated, but because the facts suggest to me that we may see a lot more of these types of claims in the coming year.

The gist of the claim is that Goldman Sachs engaged in "spinning," allocating shares in hot IPOs to Ebay officers and directors in return for sending Goldman Sachs Ebay's investment banking work. It's really a bribery claim. The plaintiffs are suing derivatively (on behalf of the corporation). They claim that the Ebay officers and directors breached their fiduciary duty to the company by taking a corporate opportunity -- the huge profits from the hot IPO shares, and that Goldman aided and abetted the breach. The elements of claims like these are well known, and this opinion does not strike out into any new legal ground.

But there must be many more of this species of lawsuit out there lurking in the bushes. Allocating hot IPO shares to favored clients was a notorious practice not so long ago, and this opinion gives plaintiffs a legal framework to hang a claim on. The defense bar is going to need to show some matching creativity.