KPMG's Aftermath -- Revenge of the Insurance Companies?

U.S. District Judge Lewis Kaplan's opinion permitting former KPMG partners and employees to seek advancement of attorney's fees from the firm sets an interesting precedent regarding the scope of the government's ability to interfere in contractual relations between employers (and principals) and their employees (and agents).  An interesting question is whether the decision might have the inverse effect in future cases because employers and principals will be less generous in providing benefits to their employees and agents, thus advancing the purpose of the Thompson Memo even though it was found to violate Due Process.

Judge Kaplan did not rule on KPMG's contractual obligation to advance the attorney's fees, although he came pretty close to finding that there is an implied-in-fact contract based on the firm's course of performance in other cases, most recently the SEC's investigation of the firm and its partners in the Xerox audit in which it paid almost $20 million in defense costs.  When business organizations see that a course of performance may bind them contractually, one way around that is to make the policies on the issue clear by putting them in writing.  KPMG did not have a written indemnification agreement, but it (and others) most likely will adopt them in the future.

The opinion also seems to imply that advancement of attorney's fees is a right all employees have, but under corporate law statutes that is certainly not the case.  The only mandatory indemnification is when the officer, director, or employee is "successful on the merits or otherwise in defense of any action" under Delaware GCL Sec. 145(c), and Model Business Corporation Act Sec. 8.52 is the same.  The other indemnification provisions in corporate law permit, but do not require, the payment of attorney's fees in advance of a decision.  Corporations and other business organizations (such as LLCs and LLPs) are free to bind themselves contractually to provide these benefits, as KPMG's course of performance may have done, but they are not required to provide such protection.

After KPMG, will corporations rethink their position on advancement of attorney's fees?  Here's where the insurance companies that provide the directors & officers (D&O) insurance may come into play.  Stories about defense costs in recent cases must send shivers down the spines of the D&O insurers because they may be on the hook for millions of dollars in defense costs with little hope of recovering any of it if the individual is found guilty.  The first three pages of the Judge's opinion list counsel for the defendants, and the firms are among the leading white collar crime practitioners in the country, and they don't come cheap.  The defense of Jeffrey Skilling in the Enron trial shows that the defense lawyer's hourly-billing meter may appear to be spring-loaded, what with dozens of lawyers and support staff committed to the case (see earlier post A License to Print Money).  Other prosecutions triggering multi-million dollar defense costs include Dennis Kozlowski (Tyco), Bernie Ebbers (WorldCom), and Richard Scrushy (HealthSouth).  What makes Scrushy's case different is that he was found not guilty, so he should have a good claim under Delaware law for mandatory indemnification of his $20+ million in defense costs. 

I suspect that D&O insurers may impose their own little Thompson Memo -- if they have not done so already -- on companies by requiring them to put into employment agreements that defense costs will be cut-off after an indictment, or the obligation will be limited to a specified percentage of the fees or subject to a cap.  Absent such a provision, the insurers may not be willing to take on the risk, or will charge a much higher premium for policies without significant limitations on their obligation to pay attorney's fees in advance.  Companies may be pressured by shareholders in a similar direction to limit their liability in cases that may triggers millions of dollars in costs to the corporation to defend an officer who could end up being sent to jail. 

The government's position in the Thompson Memo that views the payment of attorney's fees as indicative of a company's lack of cooperation was hardly defensible, and Judge Kaplan's opinion shows how the courts will react to any perceived interference with the right to counsel -- unless you're a drug dealer and there is an asset forfeiture case, but that's a different story.  Whether any future case even comes to this point is an open question, and I think companies will view the KPMG decision as a signal to avoid the problem altogether by limiting the payment of attorney's fees in a way that keeps them from having to pay after an indictment of an individual officer or employee.  That may well fulfill the goal of the Thompson Memo, if the government actually wants companies to cut-off the attorney's fees for indicted employees. (ph)