A variety of news articles and blogs have expressed surprise and even outrage that Bank of America is advancing the legal expense that former Countrywide CEO Angelo Mozilo is incurring in defending against the various claims that have been raised against him, including the recent SEC enforcement action.
There is no particular reason for me to bestir myself to justify BofA’s action, particularly since Mozilo has done such an effective job making himself look like a cartoon villain (as I discussed here). But under Delaware law and under the legal understandings that BofA reached when it acquired Countrywide, BofA has a legal obligation to advance Mozilo’s expenses. The only outrage would be if BofA refused to do so.
Countrywide was a Delaware Corporation. BofA is a Delaware Corporation. Under Section 145(e) of the Delaware General Corporation Law, companies are permitted to advance expenses directors and officers incur in defending claims brought against them for actions undertaking in their capacities as directors and officers. Most companies’ by-laws make these advancement requirements mandatory, which I presume would have been the case for Countrywide. Mozilo may even have had a separate advancement and indemnification agreement; many senior executives do. In addition, as reflected in a June 9, 2009 Bloomberg article (here), the two companies’ July 1, 2008 merger agreement specified that Bank of America would maintain Countrywide’s existing indemnification rights for six years.
There is a very good reason for the legal formality surrounding advancement and indemnification; that is, the question of entitlement to these rights usually comes up only after serious allegations have arisen. Accordingly, it is important to lock down rights and obligations at a calmer time, so that duties and expectations are clear if questions later do arise. Having entered these agreements, companies are not at liberty to dispense with the commitments simply because they later find it distasteful or repugnant to honor the commitments.
Mozilo may well be one of the most unpopular figures in the United States right now, and a lot of people want to make him the poster child for everything that went wrong with our financial system. But as reviled as some might perceive him to be, that does not deprive him of his legal rights nor does it relieve BofA, as Countywide’s successor-in-interest, of its legal obligations.
Keep in mind that Mozilo has not been convicted of anything (yet?) – indeed, though he is one of the subjects of an SEC civil enforcement action, no criminal charges have been brought against him. Nor has he yet been found liable in any of the many civil actions against him.
Indeed, even if criminal charges had been brought, Mozilo would nonetheless retain the right to advancement of his defense expenses. In considering the extent of Mozilo’s rights, it is important to recall the July 30, 2008 Delaware Chancery Court opinion (here) in which Vice Chancellor Leo Strine held that the Sun-Times Media Group had to continue to advance the defense expenses of four former officers, including Lord Conrad Black, even though: 1) the four had been convicted of various criminal offenses; 2) the four had already been sentenced; 3) the convictions had been upheld on appeal; and 4) the company had already advanced $77 million in defense expenses for the four. Vice Chancellor Strine held that under Delaware statutory law and the applicable by-law provisions, requiring advancement until "final disposition," the obligation to advance expenses continued until the "final, non-appealable conclusion" of the criminal action, which had not yet been reached.
Whatever else may be said, advancement rights are enforceable and durable. (I will leave aside the problem created by the Schoon v. Troy case, about which refer here, which did seemingly permit the retroactive elimination of advancement rights, the Delaware legislature recently created a statutory remedy for that bobble.)
BofA is of course entitled to obtain from Mozilo an undertaking to repay the expenses advanced if it is later determined that he did not act in "good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation." Mozilo is a very wealthy man, wealthy enough that if the statutory standard for repayment is triggered, BofA can try to recover the amount advanced – that is if there’s anything left at that point.
I understand that the main objection to BofA’s advancement of Mozilo’s defense expenses is that BofA has accepted $45 billion in bailout money. The objection is that taxpayers are effectively paying Mozilo’s legal fees, or something like that.
One might try to argue that, because taxpayers shouldn’t have to foot the bill, companies accepting bailout funds ought to be required to terminate advancement or indemnification rights of former officers and directors, but as far as I know there were no such requirements imposed in connection with the bailout money provided to BofA. Moreover, even though Congress has a pretty impressive record of trying to impose retroactive conditions on bailout recipients — without the slightest regard for the requirements of binding contracts — there are still some very good policy reasons why even Congress would have to hesitate to retroactively superimpose a bailout condition like that.
In any event, the objection about Mozilo’s defense expenses is not to advancement of defense expenses as a general matter, but to advancement for Mozilo in particular. There is no principled basis on which to isolate one individual, no matter how unpopular he may be, and single him out as the one person retroactively disentitled to his otherwise enforceable rights. To put it another way, if Mozilo is not entitled to advancement, then no current or former director or officer from an entity receiving bailout funds should be entitled to advancement. I suspect that even the most thick-skulled, grandstanding member of Congress would see the policy concerns with taking that position.
There is an added component to this question – that is, the extent to which Countrywide’s D&O insurance may be reimbursing BofA for its advancement of Mozilo’s defense expense. Countrywide undoubtedly carried D&O insurance, likely with limits of liability in the tens and perhaps in the hundreds of millions of dollars. The Countrywide insurance program may have had a significant self-insured retention, but that has likely been satisfied even if it is many millions of dollars.
The problem with D&O insurance as a source of reimbursement for defense expenses is that there are so many lawsuits against Countrywide and its directors and officers in so many different courts that the insurance limits could quickly be depleted or even exhausted, assuming for the sake of discussion that the carriers have not asserted defenses to coverage.
To the extent not reimbursed by insurance, BofA will have to advance Mozilo’s defense expenses. For those who still just find this too much to swallow, here’s one final thought – even if BofA is obliged to pay Mozilo’s defense expense due to an undertaking the merger documents, BofA appears to be making money from the Countrywide acquisition. According to Bloomberg (here), BofA reported mortgage-banking income in the first quarter of $3.71 billion, compared to $1.52 billion in the first quarter of 2008, "because of surging demand for home loan refinancings." This is a significant form of consolation for the fact that BofA is on the hook for Mozillo’s defense expenses.