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Weil v. Vereit Operating Partnership, L.P.

Court of Chancery of Delaware

February 13, 2018

EDWARD M. WEIL, WILLIAM M. KAHANE, NICHOLAS S. SCHORSCH, and PETER M. BUDKO, Plaintiffs,
v.
VEREIT OPERATING PARTNERSHIP, L.P., Defendant.

          Date Submitted: November 21, 2017

          Kenneth J. Nachbar, John P. DiTomo, Elizabeth A. Mullin, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Attorneys for Plaintiffs.

          Stephen B. Brauerman, Sara E. Bussiere, BAYARD, P.A., Wilmington, Delaware; Scott A. Edelman, Alan J. Stone, MILBANK, TWEED, HADLEY & MCCLOY LLP, New York, New York; Attorneys for Defendant.

          MEMORANDUM OPINION

          LASTER, V.C.

         The plaintiffs sued to enforce their advancement rights. They moved for summary judgment on a variety of issues. This decision grants partial summary judgment in their favor.

         I. FACTUAL BACKGROUND

         The facts are drawn from the pleadings and the fifty-five exhibits submitted in connection with the motion for summary judgment. Because of the procedural posture, this decision assumes for purposes of analysis that any disputes of fact will be resolved against the movants.

         A. Parties And Relevant Non-Parties

         VEREIT, Inc. is a publicly traded real estate investment trust organized under the laws of the State of Maryland. VEREIT conducts all of its business through VEREIT Operating Partnership, L.P., a Delaware limited partnership (the "Partnership"). VEREIT serves as the sole general partner of Partnership. The Third Amended and Restated Agreement of Limited Partnership (the "Partnership Agreement") governs the business and affairs of the Partnership.

         The four plaintiffs previously served as senior officers of VEREIT:

• Nicholas S. Schorsch co-founded VEREIT and served as its Chairman of the Board and Chief Executive Officer from 2011 through the last quarter of 2014.
• William M. Kahane served as President and Chief Operating Officer from December 2010 through February 2012.
• Edward M. Weil served as an Executive Vice President beginning in December 2010 and as Chief Operating Officer from February 2012 through February 2013.
• Peter M. Budko served as Chief Investment Officer and Executive Vice President from December 2010 through January 2014.

         While employed as executive officers of VEREIT, the four plaintiffs also served as members of its board of directors (the "Board").

         From VEREIT's founding until January 2014, non-party AR Capital, LLC provided management services to VEREIT, primarily through a subsidiary called ARC Advisors. During their tenure at VEREIT, the plaintiffs also held positions at AR Capital.

         B. The Underlying Matters

         On September 7, 2014, the Audit Committee of the Board commenced an investigation into alleged financial reporting irregularities at VEREIT (the "Internal Investigation"). On October 29, VEREIT filed a Form 8-K with the Securities and Exchange Commission which announced that the Audit Committee had identified errors in VEREIT's securities filings. The Form 8-K warned investors not to rely on VEREIT's annual report for 2013 and its quarterly reports for the first and second quarters of 2014. In March 2015, VEREIT announced that the Audit Committee had completed the Internal Investigation and that VEREIT had restated its annual results for fiscal years 2012 and 2013, its quarterly results for the first three quarters of 2013, and its quarterly results for the first two quarters of 2014. AR Capital and ARC Advisors provided management services to VEREIT during certain of the restated periods.

         VEREIT's disclosures prompted a range of lawsuits. Investors filed a consolidated class action, thirteen direct actions, and four shareholder derivative actions (collectively, the "Civil Actions"). Many of the Civil Actions named the plaintiffs and AR Capital as defendants.

         Generally speaking, the complaints in the Civil Actions allege that Schorsch made intentionally false statements about VEREIT's financial results and internal controls. The plaintiffs allege that Schorsch, Budko, Kahane, and Weil caused VEREIT to pay more than $900 million to entities that they controlled, including AR Capital and ARC Advisors.

         In November 2014, the SEC served a subpoena on VEREIT. The subpoena requested information about the plaintiffs' knowledge and activities in connection with the subject matter of the Internal Investigation and the Civil Actions. Subsequently, the Department of Justice and certain state regulators commenced investigations into AR Capital. This decision refers to the SEC, DOJ, and state regulator investigations as the "Government Investigations." At this point, it is unclear to what extent the Government Investigations involve the plaintiffs in their capacities as former directors and officers of VEREIT. It is also unclear whether the plaintiffs are targets of the Government Investigations.

         This decision refers collectively to the Internal Investigation, the Civil Actions, and the Government Investigations as the "Underlying Matters." The Internal Investigation has been completed. The Civil Actions and Government Investigations remain pending.

         C. The Plaintiffs Request Advancement From VEREIT.

         In November 2014, the plaintiffs retained counsel to represent them in the Underlying Matters. Budko, Kahane, and Weil retained Kellogg, Hansen, Todd, Figel & Frederick PLLC. For convenience, this decision calls them the "Kellogg Plaintiffs." Schorsch retained Paul, Weiss, Rifkind, Wharton & Garrison LLP.

         The plaintiffs initially requested advancement[1] from VEREIT. They did not also request advancement from the Partnership. That decision made sense, because in September 2011, each of the plaintiffs had entered into a detailed indemnification agreement with VEREIT that also provided for advancement. As is customary, the indemnification agreements contained a variety of specific provisions addressing aspects of the indemnification and advancement process.

         After providing VEREIT with the proper documentation to support their advancement requests, both Kellogg Hansen and Paul Weiss began sending VEREIT monthly invoices. VEREIT raised a slew of objections, delayed making payments, and paid only parts of the amounts requested.

         VEREIT's objections to the Kellogg Plaintiffs' requests included the following:

• Kellogg Hansen's invoices failed to identify expenses incurred solely on behalf of AR Capital or for the Kellogg Plaintiffs in their roles as representatives of AR Capital.
• Kellogg Hansen failed to provide adequate explanations for amounts paid to third-party vendors.
• The Kellogg Plaintiffs failed to account for amounts received from one of AR Capital's insurers when submitting bills to VEREIT.
• Kellogg Hansen failed to follow VEREIT's billing guidelines, which asked law firms to apply a 10% discount on all invoices.
• The Kellogg Plaintiffs sought advancement for their defense in the derivative actions, which VEREIT claimed to have already paid.

         Based on these objections, VEREIT refused to advance more than $12 million to the Kellogg Plaintiffs.

         VEREIT's objections to Schorsch's requests included the following:

• Paul Weiss charged excessive rates for its staff attorneys.
• Paul Weiss charged excessive fees for document review during the first six months of 2017.
• Paul Weiss consistently overstaffed the representation.
• Paul Weiss's invoices provided inadequate descriptions of the work performed.
• Paul Weiss increased its billing rates during the second year of its representation of Schorsch without receiving VEREIT's approval.
• Paul Weiss charged for amounts that were not covered under VEREIT's billing guidelines.

         Based on these objections, VEREIT refused to advance more than $5.9 million to Schorsch.

         D. This Litigation

         On August 24, 2017, the plaintiffs filed this lawsuit. Earlier that day, the Kellogg Plaintiffs had sent advancement demands to the Partnership, invoking an advancement provision in the Partnership Agreement. The lawsuit named both VEREIT and the Partnership as defendants.

         On August 29, Schorsch served the Partnership with his advancement request. That same day, the plaintiffs filed an amended complaint, which remains the operative pleading (the "Complaint").

         The Complaint focused primarily on VEREIT. Counts I-IV asserted claims for breach of the indemnification agreements or sought declaratory judgments establishing rights under the indemnification agreements. Only Count V focused on the Partnership. It sought a declaratory judgment that the Partnership was obligated to provide advancements under the Partnership Agreement.

         On September 8, 2017, VEREIT and the Partnership answered the Complaint. The Partnership took the same positions as VEREIT and made clear that it was asserting the same objections to the plaintiffs' advancement requests as VEREIT had asserted.

         On September 29, 2017, the plaintiffs moved for summary judgment. VEREIT and the Partnership cross-moved to dismiss or stay this case in deference to litigation pending in other jurisdictions, and VEREIT moved for dismissal for lack of personal jurisdiction. By orders dated December 13, 2017, I denied the defendants' motion to dismiss or stay the case and granted the motion to dismiss VEREIT for lack of personal jurisdiction. VEREIT's dismissal rendered moot the claims asserted in Counts I-IV.

         The motion for summary judgment remained pending as to Count V. This decision rules on particular objections raised initially by VEREIT and maintained by the Partnership. It does not determine a specific amount to which the plaintiffs are entitled.

         II. PROCEDURAL STANDARD

         Summary judgment is appropriate when the record shows that "there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law."[2] On a motion for summary judgment, "[t]he moving party bears the burden of establishing that there are no issues of material fact, and the court must review all evidence in the light most favorable to the non-moving party."[3] "Advancement cases are particularly appropriate for resolution on a paper record, as they principally involve the question of whether claims pled in a complaint . . . trigger a right to advancement under the terms of a corporate instrument."[4]

         III. LEGAL ANALYSIS

         Section 17-108 of the Delaware Revised Uniform Limited Partnership Act (the "LP Act") states that "[s]ubject to such standards and restrictions, if any, as are set forth in its partnership agreement, a limited partnership may, and shall have the power to, indemnify and hold harmless any partner or other person from and against any and all claims and demands whatsoever."[5] The statute "is broadly empowering and deferential to the contracting parties' wishes regarding indemnification and advancement."[6] "In fact, Section 17-108 defers completely to the contracting parties to create and delimit rights and obligations with respect to indemnification and advancement of expenses."[7] "Section § 17- 108 of the [LP Act] gives limited partnerships wider freedom of contract to craft their own indemnification scheme for a partnership's indemnitees than is available to corporations under § 145 of the DGCL, which creates mandatory indemnification rights for corporate indemnitees in some circumstances and also bars indemnification in others."[8] Drafters can "exercise[] their freedom of contract to eschew the Delaware statutory approach to corporate indemnification and create an indemnification scheme" that uses different requirements.[9] The same is true for advancement.

         Section 6.03(b) of the Partnership Agreement grants mandatory advancement rights on the following terms:

The Partnership shall reimburse an Indemnitee for reasonable expenses incurred by an Indemnitee who is a party to a proceeding in advance of the final disposition of the proceeding upon receipt by the Partnership of (i) a written affirmation by the Indemnitee of the Indemnitee's good faith belief that the standard of conduct necessary for indemnification by the Partnership as authorized in this Section 6.03 has been met, and (ii) a written undertaking by or on behalf of the Indemnitee to repay the amount if it shall ultimately be determined that the standard of conduct has not been met.[10]

         The Partnership Agreement defines the term "Indemnitee, " as any person "made a party to a proceeding by reason of its status as . . . a director, manager or member of the General Partner or an officer or employee of the Partnership or the General Partner.[11]

         When the events giving rise to the Underlying Proceedings took place, the General Partner was VEREIT.[12] The definition of Indemnitee thus includes both persons made party to a proceeding by reason of their status as officers or employees of the Partnership and persons made party to a proceeding by reason of their status as directors, managers, members, officers, or employees of VEREIT. Critically, the definition of Indemnitee does not include AR Capital, nor does it specifically call out persons made party to a proceeding by reason of their roles with AR Capital.

         As the term "Indemnitee" suggests, the advancement right in Section 6.03(b) builds upon an indemnification right that appears in Section 6.03(a). It states:

To the fullest extent permitted by law, the Partnership shall indemnify an Indemnitee from and against any and all losses, claims, damages, liabilities, joint or several, expenses (including reasonable legal fees and expenses), judgments, fines, settlements, and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, that relate to the operations of the Partnership as set forth in this Agreement in which any Indemnitee may be involved, or is threatened to be involved as a party or otherwise, unless it is established that: (i) the act or omission of the Indemnitee was material to the matter giving rise to the proceeding and either was committed in bad faith or was the result of active and deliberate dishonesty; (ii) the Indemnitee actually received an improper personal benefit in money, property or services; or (iii) in the case of any criminal proceeding, the Indemnitee had reasonable cause to believe that the act or omission was unlawful . . . .[13]

         When the two sections are read together, Section 6.03(b) provides an Indemnitee with a right to mandatory advancement as long as (i) it is possible that the Indemnitee later could be entitled to indemnification and (ii) the Indemnitee provides the written affirmation and the written undertaking required by Section 6.03(b).

         Setting aside the requirements of a written affirmation and undertaking, the resulting structure establishes a series of requirements before an individual can receive advancements. First, the proceeding must qualify for coverage. To meet this test, the proceeding must "relate to the operations of the Partnership as set forth in this Agreement." This decision sometimes refers to a proceeding that satisfies this test as a "covered proceeding."

         Second, the individual seeking coverage must qualify as an Indemnitee. For the individuals in this case, they must be involved "by reason of [their] status as . . . a director, manager or member of [VEREIT] or an officer or employee of the Partnership or [VEREIT]." This decision sometimes refers to this concept as a "covered capacity" or an "official capacity."

         Third, the Indemnitee must have a sufficient degree of involvement in the proceeding to trigger coverage. For advancement, the Indemnitee must be "a party to" the proceeding. The party requirement for advancement is notably stricter than the degree of involvement that is sufficient for indemnification, where coverage extends to any proceeding "in which any Indemnitee may be involved, or is threatened to be involved as a party or otherwise." For purposes of indemnification, a degree of tension exists between this language and the definition of Indemnitee, which speaks of a person who is "made a party to a proceeding." This decision need not examine that tension further, because it deals with advancement, not indemnification.[14] For advancement, both the language of Section 6.03(b) and the definition of "Indemnitee" require that the Indemnitee be "a party to" the proceeding.

         For purposes of this case, the Partnership accepts that the Partnership Agreement provides for mandatory advancement.[15] The Partnership accepts that the plaintiffs have provided the requisite written affirmations and undertakings. The Partnership agrees that many of the Civil Actions are covered proceedings and that, for certain aspects of those proceedings, the plaintiffs have been sued in a covered capacity.[16] Nevertheless, the Partnership has raised a series of objections to the plaintiffs' claim for advancements. This decision does not address the plaintiffs' entitlement to specific amounts in dollars and cents. Instead, it addresses the categorical objections that the Partnership has raised and, where possible, resolves them as a matter of law. As the Partnership has recognized, many of its objections do not require "the court to engage in a 'granular review'" and "can be resolved in broad strokes."[17]

         A. The Civil Actions

         The Partnership argues that the Kellogg Plaintiffs cannot recover all of the advancements they have sought for the Civil Actions. The Partnership contends that some of the amounts sought relate to claims brought against the Kellogg Plaintiffs' in non-covered capacities. It contends that other amounts relate to work for AR Capital.

         To determine whether the Kellogg Plaintiffs are entitled to advancement, the first question is whether the Civil Actions are covered proceedings. As noted, a lawsuit is a Covered Proceeding if it "relate[s] to the operations of the Partnership." All of the Civil Actions, including the aspects relating to AR Capital, clearly relate to the operations of the Partnership.

         The next question is whether the Kellogg Plaintiffs are Indemnitees. To qualify, each of the Kellogg Plaintiffs must be a "party" to the covered proceeding "by reason of" his status as an officer or employee of the Partnership or as an officer, director, manager, member, or employee of VEREIT. The Delaware Supreme Court has explained that to meet the "'by reason of" test, there must be "a nexus or causal connection" between the underlying proceeding and the function or capacity that the individual performed on behalf of the entity.[18] Elaborating, the high court held that "if there is a nexus or causal connection between any of the underlying proceedings . . . and one's official corporate capacity, those ...


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