Barry M. Klayman and Mark E. Felger

In a recent case, Vice Chancellor Sam Glasscock considered whether to grant a corporation's motion to modify an earlier advancement order where the corporation subsequently amended its claims against a former officer and director in order to eliminate the grounds for advancement. In Carr v. Global Payments, C.A. No. 2018-0565-SG (Del. Ch. Oct. 31, 2019), Glasscock held that amendment can eliminate advancement obligations, but only if the amendment and amending party's representations alter the claim in such a manner that assures the court that the party originally entitled to advancement will not face litigation by reason of the fact of the party's corporate capacity.

The facts of the case were not complicated. Heartland Payment Systems, a Delaware corporation, brought suit in a New Jersey court against Carr, the founder and former chairman and CEO of Heartland, for breach of fiduciary duty and breach of contract. The breach of fiduciary duty claims concerned alleged insider trading. The breach of contract claims concerned alleged breaches of the noncompete and nonsolicitation clauses of Carr's employment contract. The latter included allegations that he competed and solicited Heartand employees using confidential compensation and contact information obtained while Carr was a corporate official. Carr demanded advancement for his litigation expenses from Heartland but Heartland refused the request. Carr then filed an action in the Delaware Court of Chancery to compel advancement. Glasscock, in a bench ruling, found that Carr was entitled to advancement for both the breach of duty and the breach of contract claims.

Subsequently, Heartland filed an amended complaint in the underlying lawsuit in New Jersey against Carr. In addition to adding claims for breach of the duties of loyalty, trust and good faith, equitable fraud and fraud, Heartland amended the breach of contract claim to remove any allegations concerning the misuse of confidential information by Carr, leaving only the claims for breach of the noncompete and nonsolicitation provisions of the employment agreement that allegedly occurred after the termination of Carr's employment with Heartland.

Heartland then returned to the Court of Chancery and moved to modify the prior advancement order relating to the breach of contract claim (but not to the breach of fiduciary duty, loyalty or fraud claims). Heartland argued that the breach of contract claims, as amended, arose solely from Carr's conduct after he was no longer an officer or director of the company, since Heartland had eliminated the claim that he misused the company's confidential information.

Glasscock first considered whether Carr's advancement rights, which were based on contract, implicated a standard different than that found in Section 145 of the Delaware General Corporation Law. The contract promised indemnification and advancement for litigation that "arises out of or pertains to" the fact that Carr was an officer or director. Section 145, on the other hand, allows indemnification and advancement "by reason of the fact" that an individual is an officer or director. Carr argued that the standard in the contract was broader than the standard in the statute. Since the contract used the same standard for both indemnification and advancement, and the scope of the corporation's permissible indemnification powers are limited by Section 145, Glasscock concluded  that the scope of "arises out of or pertains to" is consistent with (and therefore no broader than) the "by reason of the fact" language in the statute.

Glasscock then determined that the breach of contract claim, as amended, did not arise "by reason of the fact" that Carr was an officer and director of Heartland. The "by reason of the fact" test requires a causal nexus between the litigation and Carr's official corporate capacity. Unless the claim has some nexus to the service of the employee in pursuit of his delegated corporate powers, the litigation does not arise by reason of the fact of his service. Where a former officer or director seeks to vindicate advancement rights in the face of allegations of breach of noncompete or solicitation covenants, the question is whether the allegations are significantly intertwined with covered duties so as to arise by reason of the exercise of those duties.

In resolving this question, Glasscock explained that claims arising post termination fall into two categories. If the claim relies on the misuse of confidential information learned while an officer or director, it "arises by reason of" the party's former position. If, however, the claim merely alleges a post-employment breach of a non-compete agreement, and does not allege that the party used confidential information previously learned to facilitate the breach, then the breach does not arise "by reason of" the party's former position.

Glasscock found that Heartland's amended complaint deleted all mention of the misuse of confidential information from the breach of contract claim. It eliminated any mention that Carr sought or used confidential information, that he copied any compensation plans, that he sought or had access to any confidential contract terms, or that he acknowledged in his contract the importance of confidentiality. It merely alleged a post-employment breach of a noncompete agreement without suggesting that the breach arose "by reason of" Carr's former service as an officer or director.

Since amending a claim may moot advancement rights if it substantively changes the underlying litigation, the question was whether Heartland had "truly abandoned" the claims triggering advancement, or instead simply attempted to pursue the same claims in "cosmetically redacted" form. Glasscock found it significant that, in addition to amending its complaint, Heartland represented to him at argument that it would not base its breach of contract claim on any misuse of confidential information. Heartland removed the entire confidentiality cause of action and any indication of reliance upon it, and agreed to forgo pursuit of such a claim in the future in a manner that would raise a judicial estoppel against such an action in the future. Thus, Carr's fear that Heartland would seek information through discovery that could then form the basis for a later-asserted claim for breach of the confidentiality aspects of his employment agreement was unfounded.

The manner in which this case unfolded is not uncommon. A corporation brings suit against a former officer and director for an alleged breach of an employment agreement or violation of some other duty and is then hit with a demand for advancement whereby it is faced with the prospect of financing the defense of the claims it is pursuing. The corporation then seeks to amend its claim so as to eliminate any right of advancement. In such circumstances, the court is rightfully skeptical that the amendment is a tactical one that does not truly change the substance of the underlying claim and is intended solely to defeat the right of advancement. Where the change is merely cosmetic and not substantive, the court will be reluctant to deny advancement based on the amended claims. As Glasscock concluded, the principle underlying the cases is that the amendment can eliminate advancement obligations, but only if the amendment and the amending party's representations alter the claim in such a manner that assures the court that the party claiming advancement will not face litigation by reason of the fact of his corporate capacity.

Interestingly enough, Glasscock originally ordered advancement based on both the breach of contract claim and the breach of duty claims. Heartland only sought to modify his order to the extent it concerned the breach of contract claim, and not the breach of duty claims. Thus, Carr was still entitled to advancement, albeit for fewer than all of the claims, and the prospect of future litigation, regarding which fees and expenses are covered by the advancement order and which are not, still looms large.

Barry M. Klayman is a member in the commercial litigation group and the bankruptcy, insolvency and restructuring practice group at Cozen O'Connor. He regularly appears in Chancery Court.

Mark E. Felger is co-chair of the bankruptcy, insolvency and restructuring practice group at the firm.