Ephrat v. medCPU, Inc., C.A. No. 2018-0852-MTZ (Del. Ch. June 26, 2019) (Zurn, V.C.)

In this memorandum opinion, the Delaware Court of Chancery held that two former officers and directors of a company were entitled to advancement of expenses for claims relating to post-separation use of confidential information, finding that allegations regarding post-separation use of confidential information learned pre-separation are “by reason of the fact” of their corporate status.

The underlying dispute arose when the petitioners, two former officers and directors of the company, sued to enforce their rights to payments under a separation agreement with the company. The petitioners had entered into respective separation agreements at the time of their departure from the company, which incorporated by reference the petitioners’ prior contractual obligations to maintain the confidentiality of certain company information. The company counterclaimed that the petitioners had breached the separation agreement because, among other things, they misused confidential information post-separation and therefore did not have a right to payment. The company’s certificate of incorporation provided advancement of expenses for former directors “to the fullest extent permitted by Section 145” of the General Corporation Law of the State of Delaware (“Section 145”).

To evaluate whether the petitioners were entitled to advancement to defend themselves against the company’s counterclaims, the Court considered two issues: (i) whether the post-separation conduct underlying the company’s counterclaims was “by reason of the fact” of the petitioners’ corporate status in accordance with Section 145 or in breach of personal contractual obligations; and (ii) whether the petitioners released their claim for advancement pursuant to the separation agreement.

The Court first determined that certain actions following the petitioners’ separation from the company could support a claim for advancement. The Court sided with the “weight of authority” under Delaware case law as supporting the proposition that “where the claims asserted against a defendant in an action are based on the misuse of confidential information that the defendant learned in his or her official corporate capacity, that action qualifies as being asserted ‘by reason of’ that corporate capacity.”

The Court thus held that the petitioners were entitled to advancement for certain of the company’s counterclaims which alleged that, in breaching their contractual agreements with the company, the petitioners misused or misappropriated information they learned by reason of the fact of their service to the company. The Court added that the petitioners were not entitled to advancement for the remaining counterclaims, including breach of contractual non-compete obligations, which did not allege any nexus or causal connection between such actions and the petitioners’ former roles as directors and officers of the company to satisfy the “by reason of the fact” standard.

Additionally, the Court ruled that the petitioners had not released their claims for advancement pursuant to the separation agreement. Applying New York law, the Court held that the release only covered the petitioners’ rights as employees and not officers or directors. In doing so, the Court contrasted the provision at issue, which encompassed claims “relating to or arising out of Executive’s employment,” with other release language in the agreement that specifically referenced acts as a director or officer of the company.

Finally, the Court addressed whether the petitioners were entitled to receive payment of fees on fees. The Court explained that the “nonscientific inquiry” to determine whether parties are entitled to an award of fees involves “a reasoned consideration of the issues at stake in the case and an assessment of the plaintiffs’ level of success.” The Court then determined that the petitioners had prevailed on half of the first issue relating to the use of confidential information and all of the second issue relating to an alleged release of advancement rights. The petitioners were therefore entitled to 75% of their fees incurred in pursuing the action.

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