Delaware’s Strong Pro-Advancement Policy

Advancement is a company’s payment of a covered party’s legal fees and expenses as they are incurred—often those of a current or former director or officer—before the resolution of the lawsuit or investigation that triggered the need for those fees and expenses. Indemnification, by contrast, reimburses those costs at the end of a case or investigation, and only if the individual meets the applicable standard. Delaware law treats advancement and indemnification as related but distinct rights.²

Delaware courts have repeatedly emphasized the policy importance of advancement rights. The Delaware Supreme Court has called advancement “an especially important corollary to indemnification” because it provides corporate officials with “immediate interim relief” from the out-of-pocket burden of ongoing legal expenses.³ The Court of Chancery has explained that advancement assures qualified individuals “ex ante, that they may resist lawsuits that they consider meritless, free of the burden of financing (at least initially) their own legal defense.”⁴ The Delaware Supreme Court has stressed that the policy goals of advancement rights “will only be achieved if the promissory terms of advancement contracts are enforced by courts even when corporate officials . . . are accused of serious misconduct.”⁵

Unclean Hands as a Defense to Advancement

Unclean hands is an equitable doctrine that precludes a party from obtaining relief when it “has violated conscience or good faith or other equitable principles in his conduct.”⁶ It is an affirmative defense: the invoking party bears the burden of proving it by a preponderance of the evidence.⁷ A court has broad discretion in deciding whether to apply the defense.⁸

Delaware law recognizes unclean hands as a defense to advancement, but the bar is high. The misconduct must relate directly to the matter in controversy and must have an “immediate and necessary” relationship to the claim for relief.⁹ In practice, the misconduct must concern the advancement claim itself. It cannot rest on the conduct being litigated in the underlying case.¹⁰

The defense rarely succeeds. The leading example of success is Nakahara v. NS 1991 American Trust, decided in 1998. There, trustees who were otherwise contractually entitled to advancement withdrew approximately $900,000 from the trust to pay their litigation costs—in contravention of a standstill agreement—and in a manner designed to preempt pending and anticipated court proceedings over the advancement.¹¹ The court refused to award advancement, explaining that “[e]quity does not reward those who act inequitably, even if it can be said that no tangible injury resulted.”¹²

But more often than not, unclean hands defenses have failed in the advancement context. For example, in Tafeen v. Homestore, a company argued that a former officer bought an expensive Florida home to shelter assets and avoid repaying advanced funds.¹³ The court let the defense go to trial, but the company could not prove the alleged misconduct, and the Delaware Supreme Court affirmed an award of roughly $4 million in advanced fees.¹⁴ And in Cianciulli v. Webinar.Net, a Magistrate in Chancery rejected an unclean hands defense based on allegations about how the plaintiff became a company director, because the alleged misconduct was not connected to the advancement process itself.¹⁵

The Care One Decision

The recent Care One decision stands out for its rare acceptance of an unclean hands defense—albeit in the context of a very unusual set of facts. Daniel Straus formed Care One in 1998 to operate nursing home and assisted-living facilities and served as its manager and controlling owner.¹⁶ Care One’s original operating agreement required the company to advance legal expenses to its officers.¹⁷ Androsky Lugo joined Care One in 1999 and was promoted to general counsel in 2009, which made him an officer entitled to advancement.¹⁸

In 2010, a former executive who Care One was suing demanded advancement. Straus was outraged; he described the demand as “a five-alarm fire.”¹⁹ He instructed Lugo to make sure that no one other than Straus could ever again demand advancement from Care One.²⁰ Lugo admitted at trial that he understood the instruction to cover existing officers, including himself.²¹

Lugo arranged an amendment to the operating agreement limiting advancement rights to Straus.²² But Lugo knew, because outside Delaware counsel had told him, that an amendment alone could not eliminate the vested rights of existing officers.²³ To carry out Straus’s request, waiver agreements were needed.²⁴ Lugo never sought waivers from himself or the other officers who held vested rights.²⁵ He never told Straus that the amendment fell short or that waivers would fix the problem.²⁶ Straus executed the amendment believing the goal was achieved.²⁷

More than a decade later, Care One terminated Lugo and sued him in federal court, alleging that he and Straus’s daughter had embezzled millions of dollars from Care One.²⁸ Lugo then demanded advancement.²⁹

The advancement action was assigned to Senior Magistrate Molina in the Delaware Court of Chancery, who issued a final report recommending that the court grant summary judgment for Lugo.³⁰ Care One took exceptions limited to its equitable defenses.³¹ On de novo review, Vice Chancellor Cook found genuine disputes of fact, held a trial, and ruled for Care One.³²

The court held that unclean hands barred Lugo’s claim.³³ It emphasized Lugo’s role: as general counsel, he owed fiduciary duties to the company, including a duty to keep his client fully informed.³⁴ The court found that Lugo “knowingly failed to achieve his client’s objective, to his own benefit, and never told his client of that failure or the straightforward solution.”³⁵ Had Lugo been candid, the court found, Straus would have required him either to sign a waiver or to leave the company.³⁶ Either way, “this proceeding would not exist.”³⁷

Relying on Tafeen, the court held that this misconduct bore an “immediate and necessary” relation to Lugo’s claim because it went “precisely to the continued existence of the advancement right itself.”³⁸ The court distinguished Cianciulli, where the alleged misconduct was too attenuated.³⁹ It also rejected Lugo’s argument that Straus was bound by the documents he signed but did not read.⁴⁰ Finally, the court agreed that Lugo had no duty to “self-sacrifice” his own right, but held that he “could not knowingly leave his client in the dark” about a right his client had told him to extinguish.⁴¹

The court reaffirmed Delaware’s strong policy favoring advancement, but described the facts as “a rare one-off.”⁴² Delaware courts have recognized that officers, as agents, must disclose information material to their principals, and that the chief legal officer is responsible for legal oversight.⁴³ Care One applies those principles in the advancement context, confirming that unclean hands remains a live defense where the claimant’s own misconduct is directly tied to the advancement right or process.

Key Takeaways

• Advancement remains the rule. Companies should expect Delaware courts to enforce advancement obligations reliably, even when the officer is accused of serious wrongdoing. Defenses based on the merits of the underlying case will not succeed.
• Changing advancement rights takes more than an amendment. Amending charters, bylaws, or operating agreements generally will not eliminate rights that have already vested. For corporations, Section 145(f) of the Delaware General Corporation Law bars amendments that impair rights after the relevant act or omission unless the original provision expressly allowed it, and many governing documents contain similar protective language. Companies seeking to limit existing officers’ rights should consider individual written waivers.
• Get clear advice when insiders have a stake. When a company asks its general counsel or other officers to revise documents that affect their own rights, it should obtain clear written advice on what the change will and will not accomplish, and consider independent counsel, when appropriate.
• Use unclean hands selectively. The defense is viable only where the misconduct is directly tied to the advancement right or process. Companies should identify and preserve that evidence early and be prepared to seek a trial on genuine factual disputes.