In an October 22, 2013 opinion (here) that underscores the important distinction between indemnification and advancement and that highlights the sometimes surprising extent to which corporate officials are entitled to advancement of their attorneys’ fees when claims are filed against them, District of New Jersey Judge Kevin McNulty held that Goldman Sachs must advance the costs that its former employee Sergey Aleynikov is incurring in defending himself against New York state criminal charges that Aleynikov stole high-speed trading computer source code from Goldman.
Peter Lattman’s October 22, 2013 New York Times Dealbook column about Judge McNulty’s ruling can be found here. An October 31, 2013 memorandum about the decision by Angelo Savino and Kristie Abel of the Cozen O’Conner law firm can be found here.
Goldman, Sachs & Co is a broker-dealer limited liability partnership organized under New York law. It is a non-corporate subsidiary of GS Group, a Delaware Corporation. Aleynikov was employed by GSCo from May 2007 through June 2009 as part of a team of computer programmers responsible for developing source code for GSCo’s high frequency trading system. During his GSCo employment, Aleynikov carried the title of “vice president.”
In April 2009, Aleynikov accepted a job with a start up company in Chicago. Before leaving GSCo, Aleynikov allegedly copied onto his home computer thousands of lines of confidential source code. Aleynikov was later arrested and charged federally with theft of trade secrets in violation of the Electronic Espionage Act. Aleynikov was convicted of the federal charges and sentenced to 97 months in prison. However, the Second Circuit reversed the conviction on the grounds that Aleynikov’s conduct did not fall within the scope of the charged federal offenses. Shortly thereafter, Aleynikov was indicted by a state court grand jury on charges of unlawful use of secret scientific material and unlawful duplication of computer related material. The state court charges remain pending.
Aleynikov filed a civil action in the District of New Jersey seeking indemnification for the defense expenses he incurred in the federal criminal action and seeking advancement of his defense expenses in the state criminal action. In seeking indemnification and advancement, Aleynikov sought to rely on Goldman’s bylaws, under which indemnification and advancement are mandatory presuming certain conditions were met. Goldman opposed Aleynikov’s entitlement to either indemnification or advancement, arguing that despite his “vice president’ title, Aleynikov was not an officer of his company, and that in any event, whatever indemnification rights Aleynikov may have for his successful defense of the federal criminal action, his rights are subject to set-off based on the company’s counterclaims against him for breach of contract, misappropriation of trade secrets and conversion. The parties cross-moved for summary judgment.
The October 22 Opinion
In his October 22, 2013 Opinion, Judge McNulty granted Aleynikov’s motion for summary judgment as to his claim for advancement of his defense expenses incurred in the state criminal action, and also ruled that he was entitled to “fees on fees” – that is, his fees incurred in establishing his right to advancement. However, Judge McNulty denied Aleynikov’s motion for summary judgment as to his claimed right to indemnification for his defense fees incurred in the federal criminal action. Judge McNulty held that Goldman was entitled to additional discovery in support of its counterclaims, which in turn could substantially affect that amount if any that Aleynikov might be able to recover.
In ruling in Aleynikov’s favor on his right to advancement of his attorneys’ fees incurred in the state criminal action, Judge McNulty acknowledged that the question whether Aleynikov was entitled to advancement was a “close question.” He ultimately ruled in Aleynikov’s favor in reliance on “Delaware’s strong statutory policy favoring advancement of fees” which he found to suggest that “the By-Laws should be read liberally and expansively.”
In reviewing Delaware’s strong public policy in favor of advancement, Judge McNulty answered a question that many observers might have about this case, which is — how could Goldman possibly have to pay the fees of someone who is criminally accused of stealing from the company?
Judge McNulty noted that the relevant Delaware statutes and the By-Laws require companies are designed to provide immediate assistance and to postpone the question whether or not such assistance is deserved. Judge McNulty noted that these provisions “do not distinguish between ‘worthy’ and ‘unworthy’ recipients” and they “do not distinguish between claims brought by Goldman and claims brought by outsiders.” He observed that “the advancement provision almost explicitly prioritizes speed over accuracy,” requiring the funds to be advanced subject only to an undertaking to repay.
Judge McNulty added that “in contrast to indemnification, which is reserved for persons who prevail in the underlying case, advancement if indifferent as to the underlying merits.”
In light of this strong bias in favor of advancement, Goldman did not try to argue that Aleynikov was not entitled to advancement because he was accused of stealing from the company; rather, Goldman argued that Alenikov as not entitled to advancement because, notwithstanding his “Vice President” title, he was not an officer of the company. Goldman argued that the title was a mere functional title and a reflection of “title inflation” in the financial services industry, Goldman argued that Aleynikov did not actually have any officer or even managerial functions and had not been appointed to his position pursuant the company’s putative officer appointment processes. Aleynikov presented evidence that Goldman had paid the legal fees of 51 of 53 persons who had sought them, including 15, who, like him were vice presidents.
In response to Goldman’s argument about “title inflation,” Judge McNally said that
It may be the case that Goldman (or the industry of which it is a part) had been profligate in conferring the title of vice president. If so, Goldman must bear the consequences of that profligacy. Goldman might easily have chosen to be more sparing with job titles, or to confer them in some other way. It might easily have drafted its By-Laws to restrict indemnification to a well-defined class. It did not.
Judge McNulty acknowledged that in light of the charges against McNulty, Goldman might well be unhappy having to pay Aleynikov’s defense expenses in the state criminal action; Judge McNulty said:
Goldman may understandably find this result galling; it believes that Aleynikov has stolen its property. If there is any comfort, it may lie in the fact that Goldman has also indemnified and advanced fees in cases where the conduct was alleged to be unlawful and, in the broader sense, no less harmful to Goldman, even if Goldman was not the alleged or intended victim.
But while Judge McNulty ruled in Aleynikov’s favor on the question of his right to advancement of his expenses incurred in defending the state criminal action, Judge McNulty withheld judgment on the question whether Aleynikov is entitled to indemnification for his fees incurred in his successful defense of the federal criminal action, pending discovery on Goldman’s counterclaims, which might provide an offset to Aleynikov’s claims for indemnification.
As I have noted in prior posts (refer for example here), the question of advancement often arises in the context of claims in which the person seeking advancement is accused of wrongdoing against the company. The questions also are considered in light of broadly written advancement provisions that were implemented at a time when those responsible for adopting the provisions had no way of knowing whether or not whether or not they might be the ones seeking to rely on the provisions.
Judge McNulty’s opinion highlights the extent to which courts are inclined to liberally interpret these broadly written advancement provisions. As the Cozen O’Conner memo to which I linked above notes, Judge McNulty’s opinion “demonstrates the liberality with which courts may interpret advancement provisions in corporate bylaws governed by Delaware law.”
While mandatory advancement provisions are expansive and generally interpreted liberally, they do also include a requirement that the person seeking advancement provide an undertaking to repay. Though this undertaking may have little value in many instances since the person providing the undertaking may have few resources out of which to make the repayment, the undertaking can sometimes have value. That may be the case for the legal costs that former Goldman director Rajat Gupta incurred in defending himself against insider trading allegations; as noted here, Judge Jed Rakoff ordered Gupta to repay his criminal defense fees as part of Gupta’s criminal sentencing for insider trading. (Gupta’s appeal of his conviction remains pending.)
The question of a company’s obligation to advance the defense costs of corporate officials accused of criminal wrongdoing is a recurring one, and one that is arising with increasing frequency as the governmental authorities pursue an increasingly diverse array of criminal allegations against corporate officials. As Peter Lattman noted in his Times article to which I linked above, “the question of who should pay the legal bills of an employee accused of wrongdoing has become an increasingly important topic at banks and among the white-collar bar.”
The Aleynikov case does highlight one problem that many companies face when trying to interpret who is entitled to rely on a company’s advancement provisions; that is, questions frequently occur when lover level personnel seek advancement. That is because by-law provisions often are unclear on the question of who is an officer and a company’s practices may not even conform to the by-law provisions. As the Cozen O’Conner memo noted, Judge McNulty’s opinion “illustrates the pitfalls companies may face when they fail to define precisely who is an office for purposes of entitlement to advancement or indemnification – a not uncommon situation in corporate bylaws.”
One final note about Judge McNulty’s opinion is the extent to which it emphasized the difference between advancement and indemnification. While Judge McNulty enforced a broad public policy in favor of advancement, even noting that the advancement provision here “explicitly prioritizes speed over accuracy,” indemnification is not only not automatic, but may be disputed even where the defense in the underlying claim is successful.
For a more detailed discussion of the important difference between advancement and indemnification, refer here. For a basic overview of indemnification rights and the relationship of indemnification to D&O insurance, refer to my earlier post on the topic, here. I published the earlier post as part of my series on the “Nuts and Bolts” of D&O insurance; the complete series can be accessed here.