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A New York Business Corporation Law provision that allows corporate officers to obtain indemnification does not also entitle them to legal fees incurred in establishing their reimbursement rights, a deeply divided New York Court of Appeals held Thursday. The court, which was sharply split, concluded that the statute does not recognize recovery of so-called “fees-on-fees.” Baker v. Health Management Systems Inc. answered in the negative a question certified by the 2nd U.S. Circuit Court of Appeals: Does New York Business Corporation Law require a firm to compensate officers for costs incurred in seeking indemnification? Although the New York Court of Appeals split 4-3 on the outcome, they agreed that a lack of clear legislative history leaves the statute open to interpretation. The issue arises within the framework of a federal securities fraud class action lodged against Health Management Systems Inc. (HMS) and several officers, including Phillip Siegel, in 1997. HMS and the other defendants were accused of making false and misleading statements to inflate the price of the company’s stock. The company hired Skadden, Arps, Slate, Meagher & Flom and Coleman, Rhine & Goodwin to defend HMS and the individual defendants. Siegel, however, was in a somewhat different position from the other defendants. Unlike the others, Siegel, who had joined the company three months after the alleged fraud commenced, obtained his HMS stock at the inflated price, not the lower value. He retained separate counsel from Dennis J. Block, now of Cadwalader, Wickersham & Taft in Manhattan. After all of the claims against Siegel were dismissed in 1998, he sought reimbursement under New York Business Corporation Law �� 722-724. The statute requires indemnification of corporate officers who successfully defend themselves in lawsuits involving their official capacity. It entitles officers to “attorneys’ fees actually and necessarily incurred as a result of such action or proceeding.” Southern District of New York Judge Richard Berman awarded Siegel $67,637 in attorney fees and expenses to cover Block’s defense on the underlying action. However, Berman disallowed $17,148 in litigation costs that Siegel incurred in attempting to obtain indemnification in the first instance. On appeal, the 2nd Circuit asked the New York Court of Appeals to determine whether such fees are recoverable under �� 722-724. By the narrowest of margins, the state panel said they are not. Writing for the majority, Judge Howard A. Levine said there is simply no authority in the law for the recovery Siegel seeks. “Were we to accept Siegel’s argument, the statutory right to indemnification would apply even to fees and expenses having the most attenuated link to the underlying action,” Levine said. “The literal language of the statute, when taken as a whole, does not support such a construction.” The majority said the statutory provision applying recovery only to those expenses “actually and necessarily incurred as a result of such action or proceeding” requires a far stronger nexus than exists here. Siegel’s claim, the court said, “stretches language beyond the outer limits of meaning.” The court observed that the Legislature has had several opportunities to change the operative language of the statute, and has not done so. The court also suggested that other remedies may be available, and that corporations can provide fee-on-fee indemnification through employment contracts or insurance. ‘UNSATISFACTORY RESULT’ Joining Levine were Judges George Bundy Smith, Richard C. Wesley and Albert M. Rosenblatt. Chief Judge Judith S. Kaye dissented in an opinion shared by Judges Carmen Beauchamp Ciparick and Victoria A. Graffeo. The dissenters argued that the ruling is legally unsound, and pragmatically troublesome. “Defendant-companies, behaving like respondent-company here, gain considerable leverage in keeping individual directors in the fold of a common defense, on pain of paying their own legal expenses if they seek to assert meritorious separate defenses,” Kaye wrote. “We believe the New York State Legislature did not require such a disquieting and unsatisfactory result, but permitted recovery of reasonable enforcement fees where enforcement action becomes necessary.” The dissent said the outcome of this case is inconsistent with the objective of the statute. “Given this unfortunate result, and absent legislative clarification, we certainly join majority’s concluding observation that directors would do well to provide for such indemnification in bylaws, employment contracts and insurance, if they can,” wrote the chief judge, a former commercial litigator. “Otherwise, individuals would be well advised to decline board service which, as this case shows, may be personally expensive.” Block argued the appeal for Siegel. HMS was represented by Howard I. Rhine of Coleman, Rhine & Goodwin.

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