The Supreme Court of Ohio has ruled that a corporation can’t avoid paying the legal defense expenses of a corporate director who is sued in his or her capacity as a director by claiming that the director’s misconduct, if proven, would amount to a violation of his or her fiduciary duties to the corporation.
The justices made the ruling in early July in a Trumbull County case in which a corporate director and company co-owner was sued by two other corporate directors who alleged that he violated his fiduciary duties to the corporation and its shareholders.
According to documents released by the court, in a 6-1 decision justices found that Sam M. Miller, a director and co-owner of Trumbull Industries Inc., an Ohio corporation that sells plumbing supplies, was entitled to an advancement of his legal expenses from the corporation.
Sam M. Miller had requested the advancement to cover the costs of defending a lawsuit filed against him by two other directors of the corporation, Murray Miller and Sam H. Miller.
The majority decision was authored by Chief Justice Maureen O’Connor.
In December 2002, Sam M. informed Murray and Sam H. about a new business opportunity called the Brand Company Project, according to the court’s description of the case. The company would market private-brand plumbing products for sale to manufacturers including Jacuzzi Inc. and possibly to other wholesalers.
Objecting to Sam M.’s involvement in the new venture, Murray and Sam H. insisted that he withdraw from it.
Sam M. continued his involvement in the project, however, and Murray and Sam H. filed suit against him and other participants in the Brand Company. Their complaint alleged that Sam M.’s involvement in the Brand Company Project was in violation of his fiduciary duties to the corporation and to them as shareholders of Trumbull Industries.
Sam. M. subsequently notified Murray and Sam H. that he had reimbursed himself from Trumbull Industries’ corporate funds for the costs he had incurred in preparing a defense against their lawsuit. He maintained that state statute allowed him to seek an advance from the corporation to cover his legal defense costs.
In his notification, Sam M. also maintained he would: 1) would pay back any advancements he received if it were found that his acts or omissions had been committed with a deliberate intent to injure, or with reckless disregard for the corporation’s best interests; and 2) would reasonably cooperate with the corporation in the lawsuit or proceeding for which he sought the advancement, as allowed under the statute.
Both sides filed motions seeking a declaratory judgment.
In January 2007, the trial court ordered Sam M. to reimburse Trumbull Industries for $240,068 of the $320,091 in legal fees that had been paid from corporate funds up to that time. The court based that holding on its “tentative” determination that because Sam M. was one of four defendants in the underlying lawsuit, only 25 percent of the legal fees that had been incurred were attributable to Sam M. as a corporate director, and therefore only 25 percent of the legal fees needed to be advanced by the corporation.
Sam M. filed a motion asking the trial court to reconsider and clarify its order, asserting that a review of the legal invoices that had been paid from corporate funds to date would show that 99 percent of those costs were attributable to the defense of Sam M. as a corporate director, and not to the other named defendants. Sam M. also argued that by filing the written undertaking required by state statute [R.C. 1701.13(E)(5)(a)], he had already agreed to repay at the end of the litigation any advanced legal costs to which he was not entitled. The trial court denied Sam M.’s motion.
Both sides then asked the trial court to clarify the impact of its January 2007 decision on the corporation’s ongoing obligation to advance Sam M. the costs of his legal defense.
The court issued a new ruling in June 2008 in which it found that legal work performed by the firm of Ulmer and Berne beginning March 25, 2008, had been performed exclusively on behalf of Sam M. as a corporate director.
The court therefore ordered Trumbull Industries to advance Sam M. funds to cover his bills from Ulmer and Berne from March 25, 2008, forward.
When the corporation failed to obey that order, Sam M. sought and received a finding by the trial court that Trumbull was in contempt. The trial court imposed a sanction against Trumbull of $5 per day for each day it failed to advance Sam M. funds to cover the legal services he received from Ulmer and Berne starting March 25, 2008.
The corporation, Murray and Sam H. appealed the trial court’s finding of contempt, sanction and order awarding Sam M. fee advancements.
On review, the Eleventh District Court of Appeals reversed the trial court and held that Sam M. was not entitled to indemnification for his legal defense costs from Trumbull Industries. Sam M. sought and was granted Supreme Court review of the Eleventh District’s ruling.
In the current decision, Chief Justice O’Connor wrote that in arriving at its ruling, the court of appeals had incorrectly relied on R.C. 1701.13(E)(1) and (E)(2), legal provisions that address the entitlement of a corporate director to indemnification for litigation expenses after legal claims against the director have been determined.
In this case, she wrote, Sam M.’s claims should have been considered only under R.C. 1701.13(E)(5)(a), which addresses the separate legal question of whether a corporation is obliged to make advance payments to cover a director’s legal defense costs while a lawsuit against the director is pending.
“The issue of whether Sam M. violated his fiduciary duties and, therefore, is not entitled to indemnification, is not appropriate for our review,” wrote Chief Justice O’Connor. “The only issue that is properly before this court now is whether Sam M. is entitled to advancement of expenses. Likewise, that is the only issue that should have been decided by the appellate court.”
“R.C. 1701.13(E)(5)(a) states that a director’s expenses ‘shall’ be paid by the corporation, evidencing an intent by the legislature to make advancement of a director’s expenses by a corporation to be mandatory. … (A)dvancement was required only if Sam M. complied with the terms of R.C. 1701.13(E)(5)(a)(i) and (ii).”
Chief Justice O’Connor noted that both sides agreed Sam M. “executed the requisite undertaking to comply with the terms of R.C. 1701.13(E)(5)(a),” and that he agreed to abide by the duties set forth the statute. The justice also noted that it is “undisputed that appellees received Sam M.’s undertaking.”
The court held that Trumbull is required by law to advance expenses to Sam M. and that “appellees failed to show that Trumbull opted out of the mandatory advancement requirement. Finally, we hold that Trumbull’s statutory duty to advance Sam M.’s fees arose upon receipt of Sam M.’s undertaking,” Justice O’Connor wrote.
The case was remanded to the trial court “for further proceedings consistent with this opinion.”
Chief Justice O’Connor’s opinion was joined by Justices Paul E. Pfeifer, Evelyn Lundberg Stratton, Judith Ann Lanzinger, Robert R. Cupp and Yvette McGee Brown.
Justice Terrence O’Donnell dissented.
The case is: Miller v. Miller, Slip Opinion No. 2012-Ohio-2928. Trumbull App. No. 2009-T-0061, 190 Ohio App.3d 458, 2010-Ohio-5662.
Source: The Supreme Court of Ohio