In the following guest post, Professors Benjamin Edwards and Nancy B. Rapoport, of Boyd School of Law, UNLV, present their views that a corporate law loophole in advancement and indemnification rules can force companies to pay exorbitant legal fees and even unreasonable personal expenses for directors’ defenses. The authors contend that courts should impose stricter scrutiny to prevent unethical billing practices and protect shareholders. We would like to thank Ben and Nancy for allowing us to publish their article as a guest post on this site. Here is their article.
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In a recent D&O Diary guest post, John McCarrick discussed the fees and expenses associated with defending a company’s two founders against both a criminal case (which resulted in the founders’ convictions—currently being appealed) and a civil fraud case. The law firms handling the founders’ defense have been accruing astronomical fees (around $136 million) and have sought reimbursement for expenses that included, as Mr. McCarrick highlighted:
- Food and snacks: Over $530 for gummy bears and a $581 dinner that included a $161 seafood tower.
- Travel and luxury: More than $25,800 in luxury hotel upgrades and roughly $3,000 in first-class airfare.
- Personal items: Charges for cellulite butter, a Cookie Monster toddler toy, and a pet hair roller.
- Subscriptions: Monthly Spotify charges and other personal effects.
May corporations be compelled to pay even these expenses? Delaware, Nevada, and the Model Business Corporation Act (MBCA) all authorize corporations to bind themselves to advance payments for directors defending themselves against claims for good reasons. Commentary to the MBCA stresses that “adequate legal representation often involves substantial expenses during the course of the proceeding and many individuals are willing to serve as directors only if they have the assurance that the corporation will advance these expenses.” Surely competent directors will serve even if they cannot be guaranteed that their possible future defense team will be able to pass through their cellulite butter charges to the company.
Companies forced to make advancement payments cannot be reasonably assured that they will be able to recover these fees and expenses if it turns out that an unfaithful director is not entitled to indemnification. Delaware, Nevada, and the MBCA all require directors seeking advancement to promise to repay if it is later determined that they were not properly entitled to indemnification, but these hollow promises do not make shareholders whole. Advancement contracts need not require that a director be able to pay the full bill should the director ultimately not be entitled to indemnification. A director’s ability to mount a defense should not turn on how much money he or she has available to pledge.
Yet focusing narrowly on a corporation’s contractual payment obligations or a director’s repayment capacity misses another important restraint on run-away billing. Go back and look at those expenses again and consider what ethical attorney would ever submit them? Under any state’s version of the rule about reasonable fees (the Model Rules analog is Rule 1.5), none of these expenses would be reasonable, even with client consent.
Imagine a world in which expenses like these were pushed across a lawyer’s desk to a well-heeled client paying the fees out of the client’s own budget. Any client would go ballistic, and with good reason. None of these expenses were necessary, and all signal a galling sense of entitlement.
One of us has served as a fee examiner for decades, and she always uses expenses like this as a signaling function: with expenses this shameless, what billing dysfunction lurks in the “fees” part of the lawyers’ bills? How many lawyers trailed along in useless meetings or hearings, with no real role to play other than multiplying the hours reflected in the bill? How many lawyers’ hands touched each document to “review and edit” it, tweaking only a few words? She’d be willing to bet that the bills included the junk phrases of “attention to” and “worked on” and would also be willing to bet that the incidents of rounded hours (hours ending in x.0 or y.5) were higher than statistically normal. (Rounded hours can often indicate that a professional wasn’t tracking time contemporaneously and just guessed at the total time.) Entitled expenses and bloated fees are an example of the failure to exercise billing judgment before a bill gets metaphorically pushed across a desk.
John McCarrick correctly points out that corporations must adapt to Delaware’s decision to order advancement here. Including reasonable sanity checks in advancement provisions may reduce the likelihood that sophisticated parties will find themselves in a similar situation arising out of future contracts.
But what about all the existing advancement provisions without any clear limits? Ultimately, courts should not allow themselves to become complicit in authorizing unreasonable billing practices. To be clear, state ethics rules should not be used to deny an attorney a fair market rate for services rendered. Yet courts must carefully consider whether unusually large fees and absurd expenses cross the ethical boundary.
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