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Defendants in Stock Purchase Indemnification Action Entitled to Advancement under Bylaws

by   |   May 5, 2017

In Davis et al v. EMSI Holding Co., the Delaware Court of Chancery held that officers and directors of an acquired company were entitled to advancement under the acquired Company’s by-laws for expenses incurred in defending an indemnification claim under the related stock purchase agreement.

As in many stock purchase agreements, the plaintiffs, as sellers, released claims against the acquired company, agreed to bear their own costs and expenses in the transaction, and also agreed that the indemnification provisions of the stock purchase agreement were the exclusive remedy for breaches of the stock purchase agreement. The defendant claimed that to grant the plaintiffs an advancement right would be an end run on these provisions.

The Court first rejected the defendant’s claim that the plaintiffs had waived their right to advancement. It noted that the exclusive remedy provision was irrelevant because that applied only to prosecuting a claim under the stock purchase agreement as opposed to asserting an extra-contractual right under the acquired company’s bylaws.

The Court found the provision which provided that each party to the stock purchase agreement was to bear their own costs and expenses in connection with the transaction was not controlling. The text of the provision provided that it was only applicable where it had not been otherwise agreed in the stock purchase agreement.  The Court opined that a carve out to the plaintiffs’ release of claims against the acquired company in the stock purchase agreement was “another agreement” which overrode the provision on bearing expenses.

The relevant provision of the stock purchase agreement included a broad release of the plaintiffs’ claims against the acquired entity. However, there was a carve out to the release which provided that the release did not apply to any right to indemnification the plaintiffs had as an officer or director under the relevant governing documents. The Court found the defendant’s argument that the carve out only applied to pre-existing third party claims and not to first party claims under the stock purchase agreement was illogical as the release applied to both first party and third party claims.

The Court also rejected the defendant’s argument that the carve out to the release only applied to “indemnification” and not to “advancement.” While Delaware law treats indemnification and advancement as separate rights, the acquired company’s bylaws used the term “indemnification” broadly.  More specifically, the company’s bylaws stated “the right to indemnification . . . shall include the right to be paid by the Corporation the expenses (including attorney’s fees) incurred in defending any such Proceeding in advance of its final disposition . . .”

Last, the defendants argued the plaintiffs were not entitled to advancement because they were not sued “by reason of” their status as officers and directors of the acquired company. The Court rejected the argument noting the allegations in the underlying action against the plaintiffs were that they misused their positions as officers and directors of the company in order to engage in a widespread fraud that involved the manipulation of the company’s business model and related financial reports for the purpose of facilitating a sale of the company at an exaggerated price. The allegations, couched as breaches of representations and warranties in the stock purchase agreement were not merely allegations that the plaintiffs breached specific contractual terms personal to them. Instead, the plaintiffs will be required to defend their actions as officers and directors of the company and their alleged intentional abuse of their corporate powers.