Advancement Rights Percolate Beneath Delaware Trade Secrets Lawsuits

Assume you represent a company and suspect a departed executive is competing unfairly by using the company's trade secret information. Further assume you have a case with, at least at first blush, a strong set of facts and a motivated client which wants to move quickly. But like most trade secrets cases, the suit is going to cost a lot of money and take a great deal of discovery to resolve.

How do you feel about advising your client that it may need to pay the ex-employee's legal fees as the case proceeds?

This is the reality of trade secrets lawsuits, particularly against former officers and directors of Delaware corporations. Delaware has a broad public policy that encourages individuals to serve in officer and director roles. To entice that service, Delaware corporate law allows, and virtually all company bylaws adopt, broad advancement rights.

So what is "advancement"?

The concept simply refers to a corporation's obligation to front (or, advance) legal expenses that an officer or director incurs by reason of her service to the company. Unlike indemnification, advancement means that an officer or director may have a right to receive regular payments to defray legal expense as the proceeding develops over time.

Importantly, this advancement right even can apply when the officer or director sits in an adversarial position to the company, as the officer or director would in a trade secrets misappropriation case. I have highlighted above the phrase "by reason of" because it is central to many disputes over whether an individual is properly entitled to advancement of legal fees.

Delaware courts have provided a helpful definition for this key phrase: it simply means there must be a "causal connection" between the underlying proceedings and one's official corporate capacity. See Homestore, Inc. v. Tafeen, 888 A.2d 204, 214 (Del. 2005).

There are a growing number of cases that apply the official capacity test to trade secrets cases. The courts finding advancement rights in these cases reason that where a claim is based on misuse of confidential information learned in an individual's official corporate capacity, that claim is one that qualifies as being brought "by reason of" her service to the company. There are several cases that address this, and most look at the nature of the allegations found in the underlying complaint. An example for practitioners comes from Pontone v. Milso Indus. Corp., 2014 Del. Ch. LEXIS 152 (Aug. 22, 2014), a fairly common dispute between a company and a former officer, who competed after his non-compete agreement ended. The core allegation dealt with the officer's purported misuse of trade secrets to lure away customers and employees of the former employer.

The overarching rationale that allows for advancement is that a corporate officer would not have had access to confidential information but for her service to the company. This, courts reason, provides the essential link between the challenged conduct and the official capacity needed to meet the "by reason of" language that virtually all Delaware corporations have in their bylaws.

The advancement rights that are likely available may be limited to officers and directors, as opposed to employees. But it is essential to parse carefully the language of the state's enabling statute and the corporate charter and bylaws to see who qualifies for advancement and what the precise conditions are for receiving advancement. Though many states will follow Delaware case law, there is variation among the statutory provisions and a high likelihood that a non-Delaware entity will not provide for broad advancement rights.

So for those attorneys who are filing trade secrets cases, it is essential to evaluate the potential for advancing your adversary's costs along the way. In effect, this could double your client's litigation expense.