Charney v. American Apparel, Inc., C.A. No. 11098-CB (Del. Ch. Sept. 11, 2015) (Bouchard, C.)

In this opinion, the Court of Chancery held that Dov Charney (“Charney”), the former CEO of American Apparel, Inc. (the “Company”), was not entitled to advancement of litigation fees and expenses under either the Company’s certificate of incorporation (the “Charter”) or an indemnification agreement between the Company and Charney (the “Agreement”). In so holding, the Court focused on the phrase “related to the fact” in the advancement provision of the Agreement and construed the phrase to be equivalent to the phrase “by reason of the fact” in Section 145 of the Delaware General Corporation Law (“Section 145”). The “by reason of the fact” standard requires a “‘nexus or causal connection between’ the underlying proceeding and ‘one’s office corporate capacity’”.

The Company’s board suspended and later terminated Charney as CEO of the Company. Following the suspension, the Company and Charney entered into a standstill agreement that prohibited Charney from attempting to replace directors or disparaging the Company. The Company later sued Charney, alleging that he had breached the standstill agreement. Charney filed a complaint for advancement of his fees and expenses relating to that lawsuit.

The Agreement requires the Company to advance Charney’s litigation expenses “in connection with any [proceeding] relating to any Indemnifiable Event.”  An “Indemnifiable Event” is defined as “any event…whether occurring before, on or after the date of this Agreement, related to the fact that [Charney] is or was a[n]…officer…of the Company”.

The Court analyzed whether Charney’s alleged breaches of the standstill agreement are “related to the fact that Charney is or was a director and/or officer of the Company”.  The Court rejected Charney’s argument that the phrase “related to the fact” is broader than the phrase “by reason of the fact” contained in Section 145. In so holding, the Court noted that a prior decision by the same Court had used the phrases interchangeably.  The Court also stated that dictionary definitions support treating the two phrases as interchangeable. The Court further reasoned that to construe “related to the fact” more broadly to require only a “but for” connection instead of a “nexus or causal connection” would lead to “absurd results” and “attenuated advancement obligations”. Further, the Court reasoned that to construe the phrase “related to the fact” more broadly would cause the indemnification provision in the Agreement to be invalid.

The Court, therefore, first applied the “nexus or causal connection” standard to Charney’s advancement demand pursuant to the Agreement and held that Charney’s alleged breaches of the standstill agreement were not causally connected to his former status as an officer of the Company because (i) he entered into the standstill agreement in his personal capacity, and (ii) undertook all of the alleged actions “solely in his personal capacity.” The underlying lawsuit did not allege that he had misused corporate powers as an officer.

The Court next analyzed Charney’s indemnification demand pursuant to the Charter and held that the Charter did not entitle Charney to advancement. The Charter requires the Company to indemnify any person “to the full extent permitted by” Section 145 and to advance expenses to any “officer or director” who is entitled to indemnification. Section 145 expressly permits indemnification for both current and former officers and directors. The advancement provision in the Charter, however, does not expressly require indemnification for former officers or directors. The Court concluded, therefore, that the plain language of the Charter did not require advancement to a former officer.

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