Meyers v. Quiz-Dia LLC ( 2018 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
PATRICK E. MEYERS et al., )
)
Plaintiffs, )
)
v. ) C.A. No. 9878-VCL
)
QUIZ-DIA LLC et al., )
)
Defendants. )
)
QUIZ-DIA LLC et al., )
)
Third-Party Plaintiffs, )
)
v. )
)
ROCKFORD MANAGER LLC et al., )
)
Third-Party Defendants. )
MEMORANDUM OPINION
Date Submitted: January 18, 2018
Date Decided: March 16, 2018
John T. Dorsey, Richard J. Thomas, Emily V. Burton, YOUNG CONAWAY STARGATT
& TAYLOR, LLP, Wilmington, Delaware; Bruce S. Bennett, Christopher Lovrien, JONES
DAY, Los Angeles, CA; Attorneys for Plaintiffs.
Blake Rohrbacher, Susan M. Hannigan, Elizabeth A. DeFelice, Brian F. Morris,
RICHARDS, LAYTON & FINGER, P.A., Wilmington, DE; Attorneys for Defendants.
LASTER, V.C.
In an opinion dated June 6, 2017,1 this court granted summary judgment in favor of
Greg MacDonald and Dennis Smythe, holding that they were entitled to indemnification
from defendants Quizmark LLC and QCE Gift Card LLC (together, the “Subs”) for losses
they incurred defending against claims filed against them in Colorado federal court (the
“Colorado Federal Action”). The Entitlement Decision did not quantify the amount of the
indemnification award. Instead, the decision instructed the parties to confer and stated that
if they could not agree, then MacDonald and Smythe could make an application pursuant
to Court of Chancery Rule 88.2 The parties could not agree.
MacDonald and Smythe filed the pending motion to quantify the amount of their
indemnification award. They are not the only movants. To date, Consumer Capital Partners
LLC (“Consumer Capital”) has paid all of MacDonald and Smythe’s expenses. Consumer
Capital seeks to recover those amounts from the Subs, claiming it is entitled to assert, by
way of subrogation, the indemnification rights held by MacDonald and Smythe.
This decision holds that Consumer Capital can recover $145,571.86 for the expenses
it paid for the defense of the claims asserted in the Colorado Federal Action.3 Pre- and post-
1
Meyers v. Quiz-DIA LLC, 2017 WL 2438328 (Del. Ch. June 6, 2017) (the
“Entitlement Decision”).
2
Id. at *9.
3
This decision uses the term “expenses” to refer collectively both to attorneys’ fees
and amounts paid out of pocket that might be referred to more traditionally and colloquially
as expenses. This is how Section 145 of the Delaware General Corporation Law deploys
the term. See, e.g., 8 Del. C. § 145(a) (authorizing a corporation in a proceeding other than
one brought by or in the right of the corporation to provide indemnification “against
expenses (including attorneys' fees), judgments, fines and amounts paid in settlement
1
judgment interest on the expenses shall accrue from August 21, 2015. This decision awards
Consumer Capital $125,000 in fees-on-fees for funding this enforcement action. Pre- and
post-judgment interest on the fees-on-fees shall accrue from August 30, 2017.
I. FACTUAL BACKGROUND
The facts are drawn from the Entitlement Decision and the parties’ submissions in
connection with the Rule 88 application. The Entitlement Decision ruled on cross motions
for summary judgment where the parties did not identify any material disputes of fact. The
cross motions therefore were deemed “the equivalent of a stipulation for decision on the
merits based on the record submitted with the motions.”4 Consequently, the facts recited in
the Entitlement Decision represent factual findings for purposes of the case.
A. The Parties
At the time of the events giving rise to this decision, QCE LLC (“OpCo”) was the
primary operating entity for the Quiznos sandwich shop empire. The Subs were
subsidiaries of OpCo. Quizmark was a Delaware limited liability company. QCE Gift Card
actually and reasonably incurred”); id. § 145(b) (authorizing a corporation in a proceeding
brought by or in the right of the corporation to provide indemnification “against expenses
including attorneys' fees) actually and reasonably incurred”); id. § 145(c) (mandating
corporation to indemnify a director or officer who was successful on the merits or
otherwise in defending a proceeding “against expenses (including attorneys' fees) actually
and reasonably incurred”). The out-of-pocket expenses encompassed by Section 145 are
broader than the restricted concept of “costs” in the statute that authorizes the recovery of
court costs in the Court of Chancery. See 10 Del. C. § 5106; Scion Breckenridge Managing
Member, LLC v. ASB Allegiance Real Estate Fund, 68 A.3d 665, 686–88 (Del. 2013).
4
Entitlement Decision, 2017 WL 2438328, at *1 (internal quotation marks omitted)
(quoting Ct. Ch. R. 56(h)).
2
was an Arizona limited liability company. Both Subs had operating agreements that granted
their officers a right to mandatory indemnification.
MacDonald was the Chief Executive Officer of OpCo. Smythe was the Chief
Financial Officer of OpCo. MacDonald and Smythe were also officers of the Subs.
Consumer Capital is a Delaware limited liability company controlled by Richard E.
Schaden and Richard F. Schaden. Before the restructuring discussed in this decision, the
Schadens beneficially owned a 51% interest in the Quiznos family of companies.
B. The Threatened Claims
In 2006, Quiznos engaged in a leveraged recapitalization. To fund the transaction,
OpCo borrowed a total of $875 million. OpCo subsequently suffered financial reversals.
By 2012, various funds affiliated with Avenue Capital Management II, L.P. and
Fortress Investment Group LLC (the “Funds”) had accumulated a substantial position in
OpCo’s debt. Their holdings gave them the power to declare a default under OpCo’s loan
agreements and pursue remedies as creditors. To neutralize that threat, Quiznos entered
into a complex out-of-court restructuring with its creditors (the “Restructuring”). In
practical terms, the Restructuring transferred ultimate ownership of Quiznos and its
subsidiaries, including the Subs, to the Funds.
In July 2012, MacDonald and Smythe left Quiznos. In summer 2013, the Funds
asked MacDonald and Smythe to attend meetings with Fund representatives in New York
City and Denver. Suspecting that the Funds were contemplating litigation, MacDonald and
Smythe retained Jones Day to investigate potential claims that the Funds might pursue. At
the meetings, the Funds interrogated MacDonald and Smythe about the Restructuring,
3
expressed frustration with the Restructuring and Quiznos’ post-transaction performance,
and disclosed their intention to file a lawsuit.
C. The OpCo Bankruptcy
On March 14, 2014, OpCo and a number of its affiliates—but not the Subs—filed
for bankruptcy. Their filings disclosed that “[t]he Reorganized Debtors [and the Funds]
w[ould] enter into [a] Specified Litigation Agreement” to pursue “Specified Litigation
Claims” against various individuals, including MacDonald and Smythe.5 The plan of
reorganization defined the term “Specified Litigation Claims” as encompassing “all claims
and causes of action made, or which could be made, on behalf of the Debtors [or the Funds]
against” the named individuals.6 An exhibit to the plan stated that the Funds intended to
pursue “any claims and rights they or their affiliates may have against former management
and former owners of the Company relating to the [Restructuring] and any forecasts,
projections, models, representations, or warranties made or provided in connection
therewith . . . .”7
As originally proposed, the plan sought to limit the ability of former officers like
MacDonald and Smythe to defend against the litigation that the Funds had threatened by
constraining their ability to assert counterclaims or setoffs. The plan sought to achieve this
end by discharging and enjoining the former officers from asserting counterclaims based
5
Dkt. 173 Ex. O, at 8.
6
Dkt. 226 Ex. 1, § 1.156.
7
Dkt. 173 Ex. O, at 207.
4
on pre-petition events or claiming setoffs for pre-petition amounts in any future litigation
with the debtors.8 The plan also sought to permanently enjoin former officers from
asserting counterclaims or claiming setoffs in any litigation with former Quiznos entities
or their equity holders and affiliates, including the Funds and Subs, which were included
in the definition of “Released Party.”9 As originally drafted, the plan also included
provisions that would broadly exculpate non-fiduciaries, including the Funds.10
In addition, the plan originally sought to subordinate any claims by former officers
like MacDonald and Smythe, including indemnity claims, to the rights of Quiznos’
unsecured creditors.11 Because the unsecured creditors were not paid in full under the plan,
the plan proposed to discharge the subordinated claims and prohibit them from being
asserted against both debtors and non-debtors, including the Funds.12
If these provisions had remained in the plan, then they would have significantly
prejudiced the ability of former officers like MacDonald and Smythe to respond to and
defend themselves against litigation brought by the Funds, such as the threatened claims
involving the Restructuring. The provisions would have prevented MacDonald and Smythe
8
Dkt. 226 Ex. 1, §§ 9.1 & 9.2.
9
Id. §§ 1.106, 1.126, & 9.2(b).
10
See Dkt. 226 Ex. 2, at 4, 36-37.
11
Id. at 3-4, 14-16.
12
Id. at 3-4, 14-16, 33-37.
5
from asserting counterclaims or claiming setoffs against the Funds and functionally
eliminated their indemnification rights.
To protect their rights, MacDonald and Smythe had Jones Day filed proofs of claims
in the bankruptcy proceeding. They also filed objections to the plan. The parties negotiated
a revised plan that removed the subordination provision, preserved MacDonald and
Smythe’s indemnification rights against non-debtors, and made other changes favorable to
MacDonald and Smythe.13
D. Litigation Between The Parties
On July 1, 2014, MacDonald, Smythe, and other former officers of Quiznos
demanded advancement and indemnification from the Subs based on the imminent threat
of suit by OpCo and the Funds.14 The letter sought advancement and indemnification under
what the parties have referred to as the “Assignment Agreement.” The letter asked the Subs
to “respond within 10 days.”15
On July 10, 2014, just before the ten-day period expired, MacDonald, Smythe, and
other officers of Quiznos filed this lawsuit in which they sought to establish their rights to
indemnification and advancement under the Assignment Agreement. The parties refer to
the claims seeking indemnification and advancement under the Assignment Agreement as
the “Assignment Agreement Claims.”
13
Dkt. 226 Ex. 3, §§ 1.167, 5.54, 9.76, 9.78.
14
Id. Ex. 10.
15
Id. at 2.
6
On July 22, 2014, the Funds filed the Colorado Federal Action in the United States
District Court for the District of Colorado (the “Colorado Federal Court”). The complaint
alleged that MacDonald, Smythe, and other former officers of Quiznos had induced the
Funds to participate in the Restructuring by creating financial projections that “made it
appear that the debt burden and capital structure that would remain in place post-
[Restructuring] would be sustainable and appropriate.”16 The complaint also alleged that
the projections were false or misleading. The Funds asserted claims for violations of the
federal securities laws and common law fraud. Although the complaint in the Colorado
Federal Action named multiple defendants, it focused primarily on MacDonald and
Smythe. It asserted claims for secondary liability against the other defendants.
The defendants in the Colorado Federal Action moved to dismiss the lawsuit on
various grounds. Meanwhile, in this action, I denied the Subs’ motion to dismiss the
plaintiffs’ claims.17 The parties proceeded with discovery. During that process, the
plaintiffs obtained copies of the Subs’ operating agreements and determined that those
documents provided MacDonald and Smythe with advancement and indemnification
rights.
In letters dated August 21, 2015, MacDonald and Smythe demanded advancement
and indemnification under the Subs’ operating agreements. In September 2015, the
16
Dkt. 165 Ex. 45, ¶ 65.
17
Dkt. 30.
7
plaintiffs amended their complaint to add claims under the Subs’ operating agreements.18
The parties refer to the claims seeking indemnification and advancement under the Subs’
operating agreements as the “Operating Agreement Claims.”
On September 17, 2015, the Colorado Federal Court dismissed the Colorado Federal
Action. The court did not dismiss the action on the merits, but rather held that federal
jurisdiction did not exist because the claims did not fall within the scope of the Securities
Exchange Act of 1934. The Funds appealed the ruling to the United States Court of Appeals
for the Tenth Circuit.
Consumer Capital had been paying the expenses that MacDonald, Smythe, and the
other defendants were incurring in the Colorado Federal Action. In December 2015, the
plaintiffs in this action amended their complaint for a second time.19 In this pleading,
Consumer Capital joined as an additional plaintiff and asserted claims for subrogation. In
May 2016, the plaintiffs amended their complaint for a third time. This amendment
dropped certain claims and added counts seeking indemnification and advancement under
MacDonald and Smythe’s employment agreements. Consistent with other labels, this
decision calls these counts the “Employment Agreement Claims.”
In July 2016, the parties in this action cross-moved for summary judgment. After
briefing and argument, I issued a ruling dated November 30, 2016, that dismissed the
18
See Dkt. 73.
19
See Dkt. 97.
8
plaintiffs’ claims for indemnification as premature pending the final disposition of the
Colorado Federal Action.20 I issued a ruling dated December 2, 2016, that stayed the
Employment Agreement Claims in favor of arbitration.21 In a ruling dated January 9, 2017,
I granted summary judgment in favor of the defendants on the Assignment Agreement
Claims.22 As a result of these rulings, the only claims remaining in this action were the
Operating Agreement Claims asserted by MacDonald and Smythe.
Meanwhile, on December 13, 2016, the United States Court of Appeals for the
Tenth Circuit affirmed the Colorado Federal Court’s order dismissing the Colorado Federal
Action. The plaintiffs moved to vacate my order that dismissed their claims for
indemnification as premature, arguing that the appellate decision constituted a final
disposition. The defendants argued that it was still possible for them to seek certiorari.
Whether a pending opportunity to seek certiorari rendered a decision non-final for purposes
of indemnification presented an interesting legal issue, but because there was only a short
time remaining before the deadline for seeking certiorari would pass, I stayed further
proceedings on the Operating Agreement Claims until it was known whether or not the
Funds had sought certiorari.23
20
See Dkt. 200.
21
See Meyers v. Quiz-Dia LLC, 2016 WL 7048783, at *4 (Del. Ch. Dec. 2, 2016).
22
See Meyers v. Quiz-Dia LLC, 2017 WL 7048783, at *18 (Del. Ch. Jan. 9, 2017).
23
See Meyers v. Quiz-Dia LLC, 2017 WL 87060, at *3 (Del. Ch. Jan. 10, 2017).
9
In March 2017, the deadline passed without the Funds seeking certiorari. As a result,
the dismissal of the Colorado Federal Action became indisputably final.24 This
development meant that the claims for advancement under the Operating Agreements were
moot while the claims for indemnification were now ripe. The parties agreed to provide
supplemental briefing on the indemnification issues.25
On July 7, 2017, I issued the Entitlement Decision, which held that MacDonald and
Smythe were entitled to mandatory indemnification from the Subs “for the amounts they
incurred preparing for and defending the Colorado [Federal] Action.”26 The Entitlement
Decision did not address Consumer Capital’s subrogation claim or the specific amount of
indemnification to which MacDonald and Smythe were entitled.
The Entitlement Decision instructed the parties to confer on the amount of
indemnification. The parties could not agree, and Consumer Capital, MacDonald, and
Smythe moved pursuant to Court of Chancery Rule 88 to quantify the amount of the award.
II. LEGAL ANALYSIS
In their Rule 88 application, Consumer Capital, MacDonald, and Smythe seek
indemnification for expenses totaling $1,373,164.41. Of this amount, $552,417.87 relates
to the defense of the Colorado Federal Action. Included in this amount is $203,470.44
24
The Funds refiled their claims in Colorado state court. The parties have indicated
that insurers are paying the expenses of the state court claims. Those expenses are not at
issue in this proceeding.
25
Dkt. 213.
26
Dkt. 220 at 20.
10
incurred in connection with the OpCo bankruptcy. The remaining $820,746.54 is for fees-
on-fees incurred pursuing this litigation through July 31, 2017.
The Subs have not challenged the reasonableness of any individual expenses.
Rather, they have advanced arguments designed to cut away broad swathes of the total
amount. If all of their arguments succeeded, then they would owe nothing to MacDonald
and Smythe and only $31,000 to Consumer Capital.
A. Consumer Capital’s Right To Subrogation
In what is potentially their most significant argument, the Subs focus on the fact that
Consumer Capital has paid all of the expenses that MacDonald and Smythe otherwise
would have incurred to date in the Colorado Federal Action and in this proceeding. The
Subs correctly observe that because of this fact, MacDonald and Smythe cannot recover
any amounts in their own right. Instead, Consumer Capital must proceed by way of
subrogation. The Subs believe that Consumer Capital cannot meet the requirements for
subrogation for any of Smythe’s fees or for the vast majority of MacDonald’s fees. In my
view, Consumer Capital is entitled to seek subrogation for all of the amounts that it paid
on behalf of MacDonald and Smythe.
“When a purported indemnitee has all of his indemnifiable expenses paid in full and
cannot show an out-of-pocket loss, he has no claim for indemnification under section
145.”27 This is because Section 145 represents “a statutory embodiment of the common
27
Levy v. HLI Operating Co., Inc., 924 A.2d 210, 222 (Del. Ch. 2007).
11
law of indemnification,” under which the party bringing the claim must have sustained an
out-of-pocket loss.28 As a result, when an indemnitee’s expenses have been paid by another
party, “the indemnitee lacks standing to assert an indemnification claim against the other
indemnitor in the indemnitee’s own right.”29 Under this rule, MacDonald and Smythe
cannot recover any amounts in their own right.
When another party has paid expenses on behalf of an indemnitee, that party can
seek to enforce the indemnitee’s rights by way of subrogation.30 Under this doctrine, the
payor “stand[s] in [the indemnitee’s] shoes and may demand full payment from another
party primarily responsible for the loss.”31 The payor succeeds to the right of payment held
by the indemnitee and can enforce that right to the same extent (and subject to the same
defenses) as the indemnitee.32 To succeed, the party asserting a claim for subrogation (the
“subrogee”) must show that the defendant is primarily obligated for the loss, that the
subrogee is secondarily responsible for the loss, and that by paying the loss, the subrogee
28
See 8 Del. C. §§ 145(a)-(c) (empowering a corporation to indemnify only amounts
“actually . . . incurred by the person”); see also Levy, 924 A.2d at 223.
29
Levy, 924 A.2d at 223.
30
See id. at 220-21, 223.
31
Id. at 220-21 (footnote omitted).
32
See E. States Petroleum Co. v. Universal Oil Prods. Co., 44 A.2d 11, 15 (Del. Ch.
1945); see also 5 John Norton Pomeroy, A Treatise on Equity Jurisprudence §§ 2343, 2349
(4th ed. 1918) [hereinafter Pomeroy].
12
satisfied the defendant’s liability for the loss.33 “One who pays the debt of another at his
direct or indirect request is, therefore, usually entitled to subrogation.”34 “Ultimately, each
subrogation claim turns on its specific facts and must therefore be decided on a case-by-
case basis.”35
1. Primary Versus Secondary Responsibility
The Subs claim that Consumer Capital cannot proceed by way of subrogation
because it was not secondarily liable for the loss. Absent a contractually established
hierarchy of obligations, Delaware law treats indemnitors as having equal responsibility
for a loss and does not imply any primary-versus-secondary distinction.36 Parties must
establish the secondary nature of an obligation by contract. No particular magic words are
required; the agreement need only contemplate that the indemnification obligation it
establishes is secondary to another obligation.37
33
See Levy, 924 A.2d at 220-21.
34
E. States, 44 A.2d at 15 (collecting cases); see also Pomeroy, supra, § 2347.
35
1 Donald J. Wolfe, Jr. & Michael A. Pittinger, Corporate and Commercial
Practice in the Delaware Court of Chancery § 12.08(h) (2012).
36
Chamison v. HealthTrust, Inc.—The Hosp. Co., 735 A.2d 912, 924 (Del. Ch.
1999) (explaining that when enacting the indemnification section of the Delaware General
Corporation Law, the Delaware General Assembly “created no primary-secondary
hierarchy among § 145 indemnitors . . . .”).
37
See id. (interpreting language stating that an obligation “shall be reduced by any
amount such person may collect” as establishing secondary liability); see also Sodano v.
Am. Stock Exch. LLC, 2008 WL 2738583, *14-15 (Del. Ch. July 15, 2008) (Strine, V.C.)
(interpreting language providing that any payment made under the agreement “shall be
reduced by any amount [the plaintiff] may collect as indemnification or advancement from
13
MacDonald entered into an agreement with Consumer Capital dated June 19, 2014,
which makes Consumer Capital’s indemnification obligation secondary to the
indemnification provided by the Subs. Sections 14(a) and (b) of the agreement state:
(a) The rights to payment of Indemnifiable Amounts and
advancement of Indemnifiable Expenses provided by this Agreement are
supplemental and secondary to, and not exclusive of, any rights which
Indemnitee may otherwise have against QCE Finance LLC, [OpCo] or any
of their subsidiaries or affiliates by virtue of his service as an officer of
Quiznos.
(b) In the event of any payment under this Agreement, the
Company shall be subrogated to the extent of such payment to all of the rights
of recovery of Indemnitee (including, without limitation, as to QCE Finance
LLC, [OpCo] and any of their subsidiaries or affiliates), and Indemnitee shall
execute all papers required and take all action necessary to secure such rights,
including execution of such documents as are necessary to enable the
Company to bring suit to enforce such rights.38
The Subs concede that these provisions establish the requisite hierarchy of indemnification
obligations and make Consumer Capital’s obligation secondary.
By contrast, the Subs contend that an agreement between Smythe and Consumer
Capital dated August 26, 2013, does not make Consumer Capital’s indemnification
obligation secondary. Smythe’s agreement contains a provision analogous to Section 14(b)
of MacDonald’s agreement, but it lacks language corresponding to Section 14(a) of
MacDonald’s agreement. In Section 14(a) and 14(c), Smythe’s agreement states:
(a) The rights to payment of Indemnifiable Amounts and
advancement of Indemnifiable Expenses provided by this Agreement shall
[another entity]” as sufficient to create a secondary obligation), aff’d sub nom., Am. Stock
Exch. LLC v. Fin. Indus. Regulatory Auth. Inc., 970 A.2d 256 (Del. 2009) (TABLE).
38
Dkt. 228 Ex. 17, §§ 14(a)-(b).
14
be in addition to, but not exclusive of, any other rights which Indemnitee may
have at any time under applicable law, the Company’s certificate of
formation, limited liability company agreement or the organizational
document of any Subsidiary or Affiliated Entity (collectively, the
“Constituent Documents”), or any other agreement, vote of unitholders or
managers (or a committee of managers) or otherwise, both as to action in
Indemnitee’s official capacity and as to action in any other capacity as a
result of Indemnitee’s Company Status.
***
(c) In the event of any payment under this Agreement, the
Company shall be subrogated to the extent of such payment to all of the rights
of recovery of Indemnitee, who shall execute all papers required and take all
action necessary to secure such rights, including execution of such
documents as are necessary to enable the Company to bring suit to enforce
such rights.39
Smythe’s agreement thus contains language addressing subrogation and states that the
indemnification rights granted in the agreement are “in addition to” other indemnification
rights. It does not contain an express statement that the obligations created by the
agreement are “secondary.” According to the Subs, because Smythe’s agreement lacks an
explicit reference to secondary liability, the agreement fails to establish the requisite
hierarchy of obligations. They point out that if the language in Smythe’s agreement is
sufficient, then the reference to a secondary obligation in MacDonald’s agreement becomes
surplusage.
This is a clever argument, but I do not find it persuasive. In my view, Smythe’s
agreement evidences a clear intent to establish a secondary relationship that would give
rise to subrogation. That is why the provision speaks in terms of subrogation. As in the
39
Id. Ex 16, §§ 14(a), (c).
15
Sodano case, it is natural that an entity like Consumer Capital would provide secondary
coverage for an individual who was serving as an officer of another entity and may become
liable because of the individual’s service at that entity.40 In that context, the entity that the
individual was serving logically provides primary coverage.41 Against the backdrop of the
commercial relationship, the reference to subrogation establishes a hierarchical structure
of indemnification obligations in which Consumer Capital’s responsibility is secondary.
This interpretation comports with the reading given to statutory language in the United
States Code that closely resembles the provision in Smythe’s agreement.42
The difference between Smythe’s agreement and MacDonald’s agreement does not
defeat this interpretation. MacDonald’s agreement was drafted a year later. By adding
express language stating that the obligation was “supplemental and secondary,” the parties
improved the agreement and made their intent clearer. The language in MacDonald’s
agreement is thus a better version, but the language in Smythe’s agreement does the trick.
40
See Sodano, 2008 WL 2738583, at *15.
41
See id. at *16.
42
See 42 U.S.C. § 1395y(b)(2)(B)(iv) (“The United States shall be subrogated (to
the extent of payment made under this subchapter for such an item or service) to any right
under this subsection of an individual or any other entity to payment with respect to such
item or service under a primary plan.”); Zinman v. Shalala, 835 F. Supp. 1163, 1165 (N.D.
Cal. 1993) (interpreting the language of 42 U.S.C. § 1395y(b)(2)(B)(iv) to mean that the
United States is only “secondarily liable in instances” where private insurance policies are
obligated to pay and that the United States may recover “the full amount” it has paid from
a private insurer), aff’d, 67 F.3d 841 (9th Cir. 1995).
16
Both MacDonald and Smythe entered into indemnification agreements with
Consumer Capital that contemplate secondary liability. The first requirement for Consumer
Capital to seek subrogation is therefore met.
2. Whether Consumer Capital Was A Volunteer
The Subs also claim that Consumer Capital cannot proceed by way of subrogation
for any amounts that it paid as a volunteer. The Subs argue that Consumer Capital had no
obligation to pay MacDonald and Smythe’s expenses until it entered into agreements with
them. According to the Subs, this means that Consumer Capital cannot seek to recover by
way of subrogation any amounts paid on Smythe’s behalf before August 26, 2013, or on
MacDonald’s behalf before June 19, 2014.
“[O]ne who pays the debt of another upon his own initiative, and without invitation,
compulsion or the necessity for self-protection, is usually regarded as a mere volunteer
without any standing in equity and cannot rely on subrogation.”43 A legal obligation to pay,
however, is not a requirement.44 “[T]he term ‘volunteer,’ as an exception to the right to
43
E. States, 44 A.2d at 15; see also 73 Am. Jur. 2d Subrogation § 20 (2018)
(“[S]ubrogation is unavailable for the mere stranger or volunteer who has paid the debt of
another without any assignment or agreement for subrogation, without being under any
legal obligation to make payment, and without being compelled to do so for the
preservation of any rights or property of his own.”).
44
See Schoon v. Troy Corp., 948 A.2d 1157, 1175 (Del. Ch. 2008) (holding that
corporation’s relationship with director meant that corporation was not a volunteer even
though it had no legal obligation to pay), superseded by statute on other grounds, 77 Del.
Laws Ch. 14, § 3 (2009); see also 73 Am. Jur. 2d Subrogation § 20 (2018) (“[A] person
having a direct interest in the discharge of the debt or lien is not a volunteer.”).
17
subrogate, is narrowly and strictly interpreted to allow a liberal application of the
doctrine.”45 When addressing the related area of advancement rights, Delaware decisions
have declined to apply the “volunteer” exception because it would create a perverse
incentive for companies “to delay granting advancement in the hope the person owed
advancement finds ‘an affluent aunt, best friend, or other third party to front her defense
costs’ at which point the advancement right extinguishes.”46 In my view, the same
reasoning applies for purposes of a director or officer’s right to ultimate indemnification.47
Under these precedents, “a company’s advancement or ultimate indemnification obligation
is not reduced merely because a volunteer advances or indemnifies the relevant
expenses.”48
Assuming the volunteer exception applies, Consumer Capital did not act as a
volunteer in this case. When the payor has an existing relationship with the debtor and
makes the payment to preserve and further that relationship, the payor is not a volunteer.49
45
73 Am. Jur. 2d Subrogation § 20 (2018).
46
Schoon, 948 A.2d at 1175 (quoting DeLucca v. KKAT Mgmt., L.L.C., 2006 WL
224058, at *9 (Del. Ch. Jan 23, 2006) (Strine, V.C.)).
47
Cf. Nakahara v. NS 1991 Am. Tr., 739 A.2d 770, 779 n.52 (Del. Ch. 1998)
(“Although indemnification and advancement are distinct rights, they are related concepts
that are commonly addressed in neighboring statutory provisions.”) (emphasis omitted).
48
Sodano, 2008 WL 2738583, at *16 (emphasis added).
49
See AT&T Corp. v. Clarendon Am. Ins. Co., 931 A.2d 409, 432 (Del 2007)
(holding that company was not a “volunteer” where it had an interest in demonstrating that
it would stand behind its employees); Schoon, 948 A.2d at 1175 (holding that company
was not a “volunteer” where it had asked representative to serve on board and the director’s
18
Consumer Capital had an existing relationship with MacDonald and Smythe when it began
making payments. Consumer Capital is owned by the Schadens, who had controlled
Quiznos before the Restructuring and who continue to operate businesses in the food
industry. MacDonald and Smythe were part of their management team. To be able to attract
and retain qualified persons to serve as corporate officers, the Schadens (through Consumer
Capital) needed to show that they would stand behind their employees. That commitment
was later confirmed in the written agreements. Consumer Capital is entitled to assert claims
by way of subrogation for all of the payments it made on behalf of both MacDonald and
Smythe.
B. The OpCo Bankruptcy
Consumer Capital (proceeding by way of subrogation) seeks indemnification for a
total of $552,417.87 incurred in connection with the Colorado Federal Action, including
approximately $203,470.44 in connection with OpCo’s bankruptcy. The Subs contend that
none of the expenses incurred in connection with the bankruptcy are subject to
indemnification. In my view, the Subs must indemnify Consumer Capital for those
amounts. In the bankruptcy, MacDonald and Smythe were forced to defend themselves
against the claims the Funds had threatened. This included eliminating provisions from the
bankruptcy plan that otherwise would have substantially impaired their ability to defend
themselves in the litigation that the Funds ultimately filed.
service in that position gave rise to litigation); DeLucca, 2006 WL 224058, at *9 (holding
that company was not a “volunteer” where officer served on board of company’s affiliate).
19
The Entitlement Decision held that MacDonald and Smythe were entitled to
indemnification for “amounts they incurred preparing for and defending the Colorado
[Federal] Action.”50 The Entitlement Decision further held that indemnification was not
strictly limited to formal costs of defense but rather encompassed amounts incurred
investigating the threatened claims, a process that began in summer 2013.51 The
Entitlement Decision also recognized that the filings in OpCo’s bankruptcy threatened
MacDonald and Smythe with litigation.52 As part of this proceeding, MacDonald and
Smythe have established that the Funds, OpCo, and their affiliates sought to use the
bankruptcy proceeding to foreclose MacDonald and Smythe’s indemnification rights. If
the bankruptcy plan had been confirmed as originally filed, then MacDonald and Smythe’s
ability to defend themselves in any litigation surrounding the Restructuring would have
been severely compromised.53 In the face of this threat, MacDonald and Smythe had Jones
Day file proofs of claim in the bankruptcy and raise objections to the plan, which resulted
in modifications to the plan that favored MacDonald and Smythe.
50
Entitlement Decision, 2017 WL 2438328, at *9.
51
Id. at *6.
52
Id.
53
See Dkt. 226 Ex 2, at 35.
20
This court has recognized that a party can be defending against threatened claims
when litigating a separate proceeding.54 That was the case here. When filing their proofs
of claims in the bankruptcy action and raising objections to the plan, MacDonald and
Smythe were defending against the claims that the Funds already had threatened to bring
and eventually would assert in the Colorado Federal Action. The expenses they incurred in
the bankruptcy are therefore indemnifiable. This is not because the bankruptcy itself was a
covered proceeding, but rather because the actions that MacDonald and Smythe took in
connection with the bankruptcy were part of their defense against the threatened claims
that ultimately were asserted in the Colorado Federal Action.
C. The 20% Cap
Consumer Capital (proceeding by way of subrogation) seeks indemnification for
total expenses of $552,417.87 that were incurred in connection with the Colorado Federal
Action. Plaintiffs’ counsel reached this amount by starting with total expenses of
$785,805.31, then engaging in a commendably careful and detailed process to determine
how much of the expenses to allocate to MacDonald and Smythe. The Subs dispute this
allocation and contend that Consumer Capital can only recover 20% of this amount because
MacDonald and Smythe entered into a fee-sharing arrangement with eight other defendants
in the Colorado Federal Action. Under the arrangement, the parties agreed that each would
54
See Schoon, 948 A.2d at 1170 (finding that director was defending against
threatened breach of fiduciary duty claims during books-and-records action where
company sought to develop factual basis for the fiduciary duty claims).
21
have “pro-rata (i.e., 1/10th) responsibility for the total fees and costs for Jones Day’s joint
defense of the [Colorado Federal Action], subject to any available insurance or
indemnity.”55 Together, therefore, MacDonald and Smythe would have had pro rata
responsibility for 2/10ths, or 20%, of the fees and costs for the defense.
Under Scharf v. Edgcomb Corp.,56 MacDonald and Smythe are bound by their
agreement. The Scharf decision addressed a claim for indemnification of expenses incurred
responding to an SEC investigation. Two individuals—Scharf and Greenberg—agreed to
share equally the expenses of responding to the investigation.57 As the investigation
unfolded, it focused largely on Greenberg and not on Scharf. Notwithstanding this fact,
Scharf’s expenses for certain months exceeded Greenberg’s, meaning that Scharf
accounted for more than half of the combined expenses in those months.58 When Scharf
sought indemnification, this court held that he should not be able to “achieve a more
favorable allocation” than what he had agreed to with his co-defendant. The court therefore
capped Scharf’s recovery at 50% of the total expenses, even for months when Scharf
claimed to have incurred a higher amount.59
55
Dkt. 66 Ex. 49 (supplemented response to interrogatory 4).
56
2004 WL 718923 (Del. Ch.), rev’d on other grounds, 864 A.2d 909 (Del. 2004).
57
Id. at *5-6.
58
Id. at *6.
59
Id.
22
The Scharf decision provides guidance here. Having agreed to an allocation before
they knew whether they would be entitled to shift their fees to a third party, MacDonald
and Smythe should not now be able to recut that allocation so as to impose a greater burden
on the third party than they would have borne themselves. Courts give deference to
decisions made by individuals who potentially must bear their own expenses precisely
because they have skin in the game and an incentive to act rationally and efficiently.60
During the advancement phase, the possibility that covered persons may ultimately have
to pay the bill gives them an incentive to monitor counsel.61 By contrast, once it is clear
60
See, e.g., First Fed. Sav. & Loan Ass’n v. United States, 88 Fed. Cl. 572, 585
(2009) (holding that plaintiff “had every incentive to exercise control over the work of its
counsel and to monitor closely the cost of the litigation” given the “lack of any assurance”
that it would prevail); Fla. Rock Indus., Inc. v. United States, 9 Cl. Ct. 285, 289 (1985)
(finding that “the risk of abuse” in the fee award process “is minimal because plaintiff has
no assurance of recovering and must assume it will bear the full cost of the litigation”);
Aveta Inc. v. Bengoa, 2010 WL 3221823, at *6 (Del. Ch. Aug. 13, 2010) (“A further
indication of reasonableness is the reality that when Aveta filed its motion to enforce and
paid the expenses it now seeks to recover, Aveta did not know that it would be able to shift
those expenses to Bengoa. Aveta had a potential claim to recover fees under Section 13.5
of the Purchase Agreement, but only if Aveta prevailed. If not, then Aveta would bear its
own expenses. Aveta therefore had sufficient incentive to monitor its counsel’s work and
ensure that counsel did not engage in excessive or unnecessary efforts.”); Arbitrium
(Cayman Islands) Handels AG v. Johnston, 1998 WL 155550, at *2 (Del. Ch. Mar. 30,
1998) (considering when evaluating reasonableness of fee award for bad faith litigation
that client pursuing award had faced prospect of bearing full cost of litigation), aff’d, 720
A.2d 542 (Del. 1998).
61
See Danenberg v. Fitracks, Inc., 58 A.2d 991, 997 (Del. Ch. 2012) (declining to
review individual time entries in the advancement context because “[i]f a party cannot be
certain that it will be able to shift expenses at the time the expenses are incurred, the
prospect that the party will bear its own expenses provides ‘sufficient incentive to monitor
its counsel’s work and ensure that counsel [does] not engage in excessive or unnecessary
efforts’” (quoting Aveta, 2010 WL 3221823, at *6)); accord Weil v. VEREIT Operating
23
that a third party will have to bear the cost in the form of ultimate indemnification, the
incentives change. Particularly when some categories of expenses are covered while others
are not, the powerful force of economic self-interest can cause individuals to engage in
behavior designed to increase the amount that the third party must pay. 62
In this case, MacDonald and Smythe agreed to an allocation before they knew that
the Subs would have to bear their expenses in the Colorado Federal Action. Consumer
Capital paid their expenses on that basis. Now that this court has held that the Subs must
indemnify Consumer Capital for MacDonald and Smythe’s share, there is an
understandable desire to shift more expenses into the recoverable category. The better
course is to follow Scharf and hold MacDonald and Smythe to the allocation they reached
when they faced the risk of bearing their own expenses. Because Consumer Capital stands
in their shoes for purposes of subrogation, Consumer Capital is only entitled to recover the
20% that MacDonald and Smythe would have had to pay.
The total amount of expenses incurred in the Colorado Federal Action (including
the OpCo bankruptcy) is $785,805.31. MacDonald and Smythe’s counsel excluded
$57,946 from this amount, leaving $727,859.31. Consumer Capital is entitled to
indemnification equal to 20% of this amount, or $145,571.86.
P’ship, L.P., 2018 WL 83442, at *11 (Del. Ch. Feb. 13, 2018); Horne v. OptimisCorp,
2017 WL 838814, at *5 (Del. Ch. Mar. 3, 2017).
62
See Dore v. Sweports, Ltd., 2017 WL 415469, at *14-16 (Del. Ch. Jan. 31, 2017)
(finding that covered persons modified time entries and expenses once they knew that a
third party would bear their expenses to gross up the recovery).
24
D. Fees-On-Fees
Consumer Capital, MacDonald, and Smythe seek to recover $820,746.54 for
pursuing this litigation. The Subs contend that Consumer Capital is not entitled to
subrogation for fees-on-fees, but because Consumer Capital stands in the shoes of
MacDonald and Smythe, Consumer Capital can recover fees-on-fees to the same extent
that MacDonald and Smythe could have recovered them. Plaintiffs who successfully
enforce their indemnification rights in Delaware are entitled to fees-on-fees.63 Because
MacDonald and Smythe could have recovered fees-on-fees, Consumer Capital can recover
them as well.64
Any award of fees-on-fees must be “reasonably proportionate to the level of success
. . . achieved.”65 Different methods for assessing proportionality can be used depending on
the nature of the case.66 In this case, Consumer Capital seeks an award of fees-on-fees in
the amount of $820,764.54 for expenses incurred through July 31, 2017. MacDonald and
Smythe claim to have spent a total of $1,985,901.72 pursuing the case, so this request
equates to roughly 39% of the total expenses that they incurred.
63
Stifel Fin. Corp. v. Cochran, 809 A.2d 555, 560-62 (Del. 2002).
64
See Levy, 924 A.2d at 224 (permitting co-indemnitor who sought contribution to
recover fees-on-fees).
65
Fasciana v. Elec. Data Sys. Corp., 829 A.2d 178, 184 (Del. Ch. 2003) (Strine,
V.C.).
66
See White v. Curo Texas Holdings, LLC, 2017 WL 1369332, at *17 (Del. Ch. Feb.
21, 2017).
25
The Subs point out that until August 21, 2015, MacDonald and Smythe were
pursuing only the Assignment Agreement Claims. Between the filing of the litigation and
August 21, 2015, MacDonald and Smythe incurred $735,943.21. They did not prevail on
any of the Assignment Agreement Claims. In my view, these amounts are not recoverable.
Deducting the amounts incurred before August 21, 2015, leaves a total of
$1,249,958.41. The Subs contend that Consumer Capital should only be awarded 2.4% of
this amount, which strikes me as unreasonably low. Rather, as I see it, from August 21
onward there were two large groups of claims in this case: the Assignment Agreement
Claims and the Operating Agreement Claims. The Employment Agreement Claims made
a brief appearance, but they were stayed in favor of arbitration.
MacDonald and Smythe prevailed on the Operating Agreement Claims, but lost on
the Assignment Agreement Claims. Because MacDonald and Smythe prevailed on one of
the two major categories of claims, I will start with one-half as the relevant proportion of
success. I will then further reduce this amount to reflect the fact that I have only awarded
the plaintiffs 20% of the expenses they sought for the Colorado Federal Action.
Multiplying the two percentages results in a fees-on-fees percentage of 10%. Applying this
percentage to the base amount of $1,249,958.41 results in a fees-on-fees award (rounded
up) of $125,000.
In my view, this amount is reasonable. The degree of success that MacDonald and
Smythe enjoyed could have been achieved simply by moving for summary judgment on
the Operating Agreement Claims. In my experience, briefing on such a motion likely would
have cost between $100,000 and $200,000. My award of $125,000 falls within that
26
expected range. It represents a reasonable amount for the degree of success that the
plaintiffs achieved.
E. Pre-Judgment Interest
“Without interest on expenses actually paid [by an indemnitee], indemnification
would be incomplete.”67 “Pre-judgment interest is awarded to compensate the indemnitee
for the use of the money while such indemnitee was entitled to it, and not by any
wrongdoing by the corporation. Interest in this situation begins to accrue when the claim
for indemnification is made.”68 This means “the date when [the plaintiff] specified the
amount of reimbursement demanded and produced his written promise to pay.” 69 Part of
the rationale behind requiring a plaintiff to make a demand is “that the responding
corporation could not be expected to guess at its obligation and that it should only pay
interest from the time it fairly had the opportunity to satisfy the plaintiff’s demand for
reimbursement.”70
Delaware courts have not addressed whether the demand must specify the source of
the advancement or indemnification right. Given the silence in the case law, MacDonald
and Smythe posit that pre-judgment interest and fees-on-fees should run beginning on July
67
Merritt-Chapman & Scott Corp. v. Wolfson, 321 A.2d 138, 144 (Del. Super.
1974), superseded by statute on other grounds, 6 Del C. § 145(k).
68
Wolfe & Pittinger, supra, § 8.02[g].
69
Citadel Hldg. Corp. v. Roven, 603 A.2d 818, 826 n.10 (Del. 1992).
70
Citrin v. Int’l Airport Ctrs., 922 A.2d 1164, 1168 (Del. Ch. 2006) (Strine, V.C.).
27
1, 2014, when they made their first demand for advancements. The Subs disagree. They
claim that parties routinely identify the source of the advancement or indemnification right
and that an entity should not be forced to incur pre-judgment interest unless it can evaluate
fairly the right being asserted. Because MacDonald and Smythe did not assert their rights
under the Subs’ operating agreements until August 21, 2015, the Subs contend that interest
should not begin accruing until that date.71
In my view, the Subs have the stronger argument. MacDonald and Smythe made
their demand under the Subs’ operating agreements on August 21, 2015. Until this date,
the operating agreements were not at issue. Interest should not begin to run until a plaintiff
makes its demand under the obligation that gives rise to the recovery. Therefore, pre-
judgment interest will accrue on the underlying amounts beginning on August 21, 2015.
Pre- and post-judgment interest will accrue at the statutory rate, compounded quarterly.72
Pre-judgment interest will accrue on the fees-on-fees from August 30, 2017, which is the
date when the plaintiffs submitted their demand for enforcement expenses and supporting
invoices to the Subs.
71
At oral argument, the Subs introduced a new date, March 13, 2017, as the date
from which pre-judgment interest and fees-on-fees should begin to run. Dkt. 236 at 19. The
Subs argued that this is actually the correct date because it is the date on which the deadline
to seek certiorari passed in the Colorado Federal Action, making MacDonald and Smythe’s
indemnification claims ripe. While there is some intellectual merit to this date, it was raised
too late to be considered. See Emerald P’rs v. Berlin, 726 A.2d 1215, 1224 (Del. 1999)
(“Issues not briefed are deemed waived.”).
72
See 6 Del. C. § 2301(a).
28
III. CONCLUSION
The Subs shall pay Consumer Capital $145,571.86 as indemnification for the
Colorado Federal Action plus $125,000 in fees-on-fees. Pre-judgment interest on the
former will accrue beginning on August 21, 2015. Pre-judgment interest on the latter will
accrue beginning on August 30, 2017. Interest will accrue on all amounts at the legal rate,
compounded quarterly, until the date of payment.
29