Submitted: March 18, 2014
Philip A. Rovner, Esq., Jonathan A. Choa, Esq., POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Valeria Calafiore Healy, Esq., HEALY LLC, New York, New York; Attorneys for Plaintiff.
Brian M. Rostocki, Esq., John C. Cordrey, Esq., REED SMITH LLP, Wilmington, Delaware; Steven Cooper, Esq., Danielle J. Marlow, Esq., REED SMITH LLP, New York, New York; Attorneys for Defendants.
PARSONS, Vice Chancellor.
This Memorandum Opinion addresses the exceptions of Defendant Milso Industries Corporation (''Milso'') to the Second Report of the Special Master in this corporate advancement action. I begin by briefly reciting the relevant background and then turn to my analysis of the exceptions.
Plaintiff is Harry Pontone; Defendants are Milso and The York Group, Inc. (''York''), of which Milso is a wholly owned subsidiary. Pontone formerly served as an officer and director of both organizations, which are active in the death care industry and, in particular, casket manufacturing. In this litigation, Pontone seeks advancement from Defendants of his legal fees and expenses incurred in connection with ongoing litigation between the parties in the United States District Court for the Western District of Pennsylvania (the ''Pennsylvania Action''). Pontone, his son Scott Pontone, and the Batesville Casket Company (''Batesville'') are the defendants in the Pennsylvania Action. Defendants here, along with their parent company, Matthews International Corporation (''Matthews''), are the plaintiffs in that action (the ''Pennsylvania Plaintiffs'').
The Pennsylvania Plaintiffs initiated the Pennsylvania Action on August 16, 2010, and amended their complaint to add Pontone as a defendant on February 28, 2011. The Pennsylvania Plaintiffs allege that, beginning in early 2010, Pontone, while still employed by York and Milso, participated in a wrongful scheme with Scott to induce several of the Pennsylvania Plaintiffs' employees and many of their most lucrative customers to move to Batesville, one of York and Milso's principal competitors. The Pennsylvania Plaintiffs further allege that, since his retirement from York and Milso in September 2010, Pontone has continued to solicit the companies' customers on behalf of his son and Batesville, under the guise of selling insurance for a nonparty insurance company. The Pennsylvania Plaintiffs claim that these actions violated Pontone's employment contract with York and Milso (the ''Employment Agreement''), which included express non-compete and non-solicitation covenants, as well as the common law. The Pennsylvania Plaintiffs have asserted numerous claims against Pontone, including for breach of contract, breach of fiduciary duty, tortious interference with contractual relations, unfair competition, and unjust enrichment. In response, Pontone has asserted a number of counterclaims against the Pennsylvania Plaintiffs, which are discussed in greater detail infra.
On June 12, 2012, Pontone filed his complaint in this action, claiming a right to receive indemnification and advancement from Defendants for attorneys' fees and expenses he has incurred and will continue to incur in connection with the Pennsylvania Action. York and Milso each have bylaws that provide their officers and directors with indemnification and advancement rights, but the parties dispute the precise scope of those rights. Before filing his complaint, Pontone unsuccessfully requested indemnification and advancement from Defendants.
In an oral ruling on January 17, 2013, I granted in part a motion by Pontone for partial summary judgment, holding that, under Milso's bylaws, Pontone was entitled to advancement of any reasonable legal fees and expenses he incurred in defending himself in the Pennsylvania Action. I denied summary judgment as to York's advancement obligations, finding York's bylaws ambiguous as to whether they provided for mandatory or permissive advancement. I also directed the parties to follow the procedures set forth in Fuhlendorf v. Isilon Systems, Inc. to process Pontone's then current and ongoing requests for advancement from Milso. On May 13, 2013, I entered an order implementing the summary judgment ruling and appointing a Special Master to resolve any disputes between the parties as to the amount of fees and expenses properly subject to advancement. That order was partially amended on August 9, 2013 (the ''August Order'').
On November 12, the Special Master issued his Second Report, which addressed Milso's objections to Pontone's requests for advancement submitted in March, May, June, and July of 2013. In that report, the Special Master overruled most of Milso's objections. On November 27, pursuant to the procedure established by this Court's orders, Milso filed a notice of exceptions to the Special Master's Second Report. After extensive briefing, I heard argument regarding Milso's exceptions on March 18, 2014. This Memorandum Opinion constitutes my ruling on those exceptions.
Milso takes exception to the Special Master's Second Report on the grounds that it:
1. Contains fundamental errors pertaining to the legal standard and determination of which counterclaims are advanceable under Delaware law;
2. Improperly determines the portions of the advancement requests relating to Pontone's intrusion on seclusion counterclaim;
3. Fails to provide that any ''fees on fees'' will be discounted to properly and proportionately account for Milso's success;
4. Improperly holds that Pontone's supplemental explanations for certain claimed fees are adequate; and
5. Fails to discount the interest charged to Milso based upon the inadequacy of the invoices provided.
For the reasons that follow, I find some merit to Milso's first exception in that I conclude the standard applied by the Special Master to determine which counterclaims were advanceable was overbroad and that two of the eight challenged counterclaims for which the Special Master recommended advancement are not properly subject to advancement. Milso's remaining exceptions are overruled. I address below the five exceptions seriatim. Because the first exception involves the most complicated legal and factual issues, I treat it in greater depth.
A. Exception 1
Milso's first exception is that the Second Report contains fundamental errors pertaining to the applicable legal standard and determination of which of Pontone's counterclaims in the Pennsylvania Action are advanceable under Delaware law. I consider, first, whether the Special Master applied the correct standard. I then address, under the controlling standard, whether the Special Master properly determined which of Pontone's counterclaims are subject to advancement.
1. Legal Standard for Advancement of Counterclaims
Advancement is permitted, but not required, under 8 Del. C. § 145(e). When provided for in a company's bylaws, advancement is a contractual right arising from those bylaws. Milso's bylaws provide for both indemnification and advancement and employ the broadly worded conventional language for such bylaws. Thus, Milso is required to provide to current and former officers and directors, such as Pontone, advancement of expenses incurred ''in defending'' any action brought ''by reason of such person being or having been a director or officer.'' I previously held that the Pennsylvania Action constitutes such an action. Therefore, whether Pontone's counterclaims in the Pennsylvania Action are advanceable ultimately turns on whether they qualify as having been asserted ''in defending'' against the affirmative claims made in the Pennsylvania Action.
To determine whether Pontone's counterclaims were asserted ''in defending'' against the affirmative claims, and thus are advanceable, the Special Master applied the standard set forth by the Delaware Supreme Court in Citadel Holding Corp. v. Roven. In that regard, the Special Master examined whether Pontone's counterclaims were: (1) ''necessarily part of the same dispute'' as the Pennsylvania Plaintiffs' affirmative claims; and (2) ''advanced to defeat, or offset, '' those claims.
As to the first prong of the test applied by the Special Master, Milso argues that, at a minimum, Delaware law requires counterclaims to qualify as compulsory under the traditional test used by Delaware and federal civil procedure in order to be ''necessarily part of the same dispute'' and eligible for advancement. Milso contends that, in contravention of this standard, the Special Master merely looked to whether Pontone's counterclaims were intertwined with the affirmative claims in some general sense and thus improperly found numerous non-compulsory counterclaims to be subject to advancement. As to the second prong of the test, Milso asserts that the Special Master erred in concluding that advancement is required for counterclaims that are capable of merely offsetting, but not defeating, affirmative claims. According to Milso, advancement is only appropriate for counterclaims that have the potential to negate one or more of an opposing party's affirmative claims.
On the first point, I agree with Milso that the touchstone utilized by Delaware courts to determine whether a counterclaim is ''necessarily part of the same dispute, '' and thus eligible for advancement, is whether the counterclaim would qualify as compulsory under the prevailing Delaware and federal procedural standard. In Roven, the plaintiff, who was covered by his former employer's advancement bylaw, sought advancement for the costs of defending an action brought against him by his former employer, including the costs of asserting various counterclaims. After noting that the plaintiff's counterclaims were compulsory under federal procedural rules, and thus would be waived if not raised, the Court held that the counterclaims qualified for advancement because they were ''necessarily part of the same dispute and were advanced to defeat, or offset'' the affirmative claims.
Since the decision in Roven, Delaware courts repeatedly have held that the baseline requirement for a counterclaim to be advanceable is that it qualify as compulsory. In Zaman v. Amedeo Holdings, Inc.,  this Court clarified that the relevant inquiry in that regard is whether the counterclaim would qualify as compulsory under the traditional test used by the Delaware and federal civil procedure rules, not whether it actually qualifies as compulsory under the rules of the jurisdiction where it was asserted.
This refinement avoids the anomaly that previously existed in some states in which, by rule, all counterclaims are defined as permissive. Absent the refinement, for litigation pending in such states, no counterclaims could be considered defensive or advanceable, even though estoppel might preclude those claims from being asserted later. The holding in Zaman thus prevents a corporate official's advancement rights from varying in ''accordion-like'' fashion based on the jurisdiction where he or she is sued.
According to Federal Rule of Civil Procedure 13 and its Delaware analog, a counterclaim is compulsory if it, among other requirements, ''arises out of the transaction or occurrence that is the subject matter of the opposing party's claim.'' Application of the standard articulated in Zaman, therefore, serves to ensure the factual interrelatedness of affirmative claims and advanceable counterclaims. That is, a counterclaim will qualify as ''necessarily part of the same dispute'' as an affirmative claim against which it is purportedly defending if, and only if, it would qualify as compulsory under the prevailing Delaware and federal procedural standard. Indeed, in Zaman and ...