Read a student law review article critically analyzing this decision here.
On July 3, 2012, the Supreme Court of Ohio issued a merit decision in Miller v. Miller, 2012-Ohio-2928. At issue in this case is the interpretation of Ohio’s corporate advancement statute, codified at R.C. 1701. 13 (E)(5).
Trumbull Industries is an Ohio corporation that sells plumbing supplies. Two sets of cousins owned stock: one set was comprised of brothers Murray and Sam H.Miller and the other set was comprised of brothers Sam M. Miller and Ken Miller. The appellees in this case are Trumbull Industries, Murray and Sam H. Sam M is the appellant. The facts and procedural history of the case are very complicated, but I will try and boil them down.
Daniel Umbs is the former president of Briggs Plumbing Products, one of Trumbull’s suppliers. Briggs entered into a contract with Jacuzzi Inc. to sell plumbing products to Jacuzzi. Without telling the appellees, Sam M. got involved with Umbs in negotiating a more favorable contract to sell plumbing products to Jacuzzi. Sam M. called this the Brand Company Project.
On December 4, 2002, Sam M. sent a memorandum to Sam H., Murray, and the Company shareholders, informing them of a business opportunity “involving a company that would market private-brand plumbing products for sale to manufacturers and possibly other wholesalers, including Jacuzzi.” Sam M. called this business opportunity the “Brand Company project.” The appellees demanded that Sam M. cease and desist. He didn’t, continuing to work with Umbs on the Brand Company project.
In February 2003, Murray and Sam H., individually and as shareholders, directors, and/or officers of Trumbull, filed a complaint for injunctive relief and damages against Sam M. and Umbs. The complaint alleged that Sam M. and Umbs had usurped a business opportunity that belonged to the company.
On September 26, 2005, Sam M. sent a memorandum to Murray and Sam H., informing them that he had reimbursed himself for his legal expenses, attaching a copy of his September 13 “undertaking” executed pursuant to R.C. 1701.13(E)(5)(a). In the undertaking, Sam M. expressly agreed to abide by all statutory provisions.
On December 15, 2006, both sides moved for declaratory judgment on the issue of Sam M.’s right to indemnification of attorney fees. The trial judge ordered the plaintiffs to reimburse Sam M. for fees he had already incurred, and to advance payments for ongoing legal expenses. When the company refused, the trial court held it in contempt. The company appealed the contempt order, but the main focus of the appeal was that the trial court was incorrect in ordering the company to advance Sam M.’s fees during the course of the litigation. The 11th District Court of Appeals reversed, in a decision with a separate concurrence and a dissent. Read the preview of this case and the oral argument analysis here and here.
In a 6-1 decision authored by Chief Justice O’Connor, the Supreme Court reversed the court of appeals, and held that Sam M. was entitled to the advancement of his litigation expenses.
The high court noted that in 1986 the General Assembly amended R.C. 1701.13 to provide for the advancement of expenses from a corporation to a director, and that this was its first occasion to review this statute. The Court stated its intention to look to Delaware, the haven for such matters, for guidance.
Advancement versus Indemnification
The Court began its analysis by making a very important distinction between “advancement” and “indemnification,” cautioning that though the terms were related, they were not synonymous. This case is about advancement, not indemnification as the trial court and the parties declared. Advancement occurs before the fact; indemnification after. Underscoring the importance of advancement, Chief Justice O’Connor quoted the Delaware Supreme Court: “[a]dvancement is an especially important corollary to indemnification as an inducement for attracting capable individuals into corporate service.”
R.C. 1701.13(E)(5)(a) requires the advancement of expenses by a corporation to a director. R.C. 1701.13(E)(1) and (E)(2) pertain to indemnification of expenses. The Supreme Court first found, as had the court of appeals, that section (E)(5)(a) is mandatory. But the Eleventh District had tied the two sets of provisions together, finding that in order for the advancement of expenses to be mandatory, the litigation had to be of the type described in subsection (E)(1) or (E)(2)—namely litigation in which a director is acting on behalf of the corporation, and in its best interest, which it detemined Sam M. clearly wasn’t. Essentially, the court of appeals held the advancement statute did not apply in this scenario, because Sam M. wasn’t doing anything for the good of Trumbull Industries, and in fact was breaching his fiduciary duties as a director.
The high court disagreed with this analysis, and uncoupled the two sets of statutory provisions, finding that the advancement of fees is “neither determined by nor dependent on whether a director is entitled to indemnification…Allowing corporations to avoid advancement by asserting that a director breached his fiduciary duty would make the advancement statute pointless,” O’Connor wrote. The Court thus held that a corporation could not avoid its duty to advance expenses to a director by alleging a breach of fiduciary duty that if proven, would bar indemnification. The Court held that the issue of Sam M.’s entitlement to indemnification was not before it.
The high court majority also rejected as waived appellees newly-raised argument that Sam M. wasn’t entitled to advancement of expenses, because he was acting as an officer, not a director, and advancement is limited to directors.
Opting Out of Mandatory Advancement
Although advancement of a director’s expenses is mandatory, a corporation may opt out of this requirement if the company’s articles of incorporation specifically state that the advancement provision does not apply. But the Court found that Trumbull’s articles of incorporation did not.
The Requirement of an Undertaking
Advancement of expenses, while mandatory, is not automatic. It is triggered upon the corporation’s receipt of what is known as an undertaking, pursuant to R.C. 1701.13(E)(5)(a)(i) and (ii). Under these provisions, a director must agree to undertake repayment of the advances if it is proven by clear and convincing evidence that the director’s actions or inactions were done with deliberate intent or reckless disregard to injure the corporation, and the director must agree to reasonably cooperate with the corporation in the suit or proceeding.
In this case the Court found that Sam M. had executed the proper undertaking on September 13, 2005, and rejected, as unsupported by the record evidence, the appellees’ argument that Sam M.’s agreement to co-operate was a sham. Responding to the dissent, the Court also held that when a director is being sued by his own company, the duty of reasonable co-operation should not “require the director to surrender his right to defend himself.”
In sum, the Court held that Trumbull was required to advance Sam M.’s expenses, and this duty arose upon receipt of Sam M.’s undertaking. The Court also held that Trumbull had not opted out of the mandatory advancement requirement. The Court of Appeals was reversed.
Justice O’Donnell’s Dissent
Justice O’Donnell, clearly deeply offended by Sam M.’s conduct, described this case like this:
“This case concerns whether a director of a closely held corporation who has fraudulently usurped a corporate opportunity for personal benefit in breach of a fiduciary duty may compel the corporation to advance expenses, including attorney fees, to defend a lawsuit brought to recover damages for that misconduct.”
As I always tell my students, it’s all in how you define the issue.
The key points in Justice O’Donnell’s dissent are that a director who is a party opponent sued by the corporation could not possibly reasonably co-operate with the corporation, and therefore could not fulfill the terms of his required undertaking. He does not believe the advancement statute applies where a corporation is suing one of its own directors. He also accepted the appellee’s argument, even though raised for the first time at the Supreme Court level, that Sam M. was acting as an officer, not as a director, during the events in question, and thus the advancement statute was not triggered. Finally, he urged the General Assembly to revisit this statute and eliminate the requirement to advance fees when the corporation is suing one of its own directors.
1. A corporation cannot avoid its duty to advance expenses to a director under R.C. 1701.13(E)(5)(a) by claiming that the director’s alleged misconduct, if proven, would amount to a violation of his or her fiduciary duties and would therefore foreclose indemnification.
2. When a corporation has received from a director the undertaking described in R.C. 1701.13(E)(5)(a), the corporation is required to advance expenses to the director unless the corporation’s articles or regulations specifically state that R.C. 1701.13(E) does not apply to the corporation.
The only thing I missed on this one was unanimity. After oral argument, I wrote, “the Court, probably unanimously, is likely to find that Sam M. was sued as a director, that under the plain language of the statute, his attorney fees must be advanced, subject to recoupment, and that the company could have taken advantage of the opt-out provisions in its articles of incorporation, but failed to do so.”
There is a clear best practices message here—for corporations wishing to avoid the mandatory advancement provisions, their articles of incorporation should clearly so state, referencing the appropriate statutory provisions. Whether that is desirable, I couldn’t say—this if very far from my field of practice. Also, no justice appeared to approve of what Sam M. had allegedly done—at argument, Justice McGee Brown wanted to make very sure that there was an opportunity for recoupment if the plaintiffs were successful in their allegations of breach of fiduciary duty. The answer was yes, which probably helped.
This was also a victory for the Ohio State Bar Association, which filed an amicus brief on behalf of Sam M. The OSBA was the driving force behind the enactment of the corporate advancement statute, to get qualified individuals to agree to serve as directors and to keep corporations from leaving the state.