Neal v. Neumann Medical Center

• Citation: 667 A.2d 479
• Parties: Gerald D. NEAL, Michael Callan, James O'Connor and Parish Patel, Appellants, v. NEUMANN MEDICAL CENTER.
• Decision Date: 16 November 1995
• Court: Pennsylvania Commonwealth Court

Page 479

667 A.2d 479

Gerald D. NEAL, Michael Callan, James O'Connor and Parish

Patel, Appellants, v. NEUMANN MEDICAL CENTER.

Commonwealth Court of Pennsylvania.

Argued May 9, 1995.

Decided Nov. 16, 1995.

Jeffrey S. Saltz, for appellants.

Stuart D. Fiel, for appellee.

Before McGINLEY, and SMITH, JJ., and LORD, Senior Judge.

LORD, Senior Judge.

Gerald D. Neal, Michael Callan, James O'Connor and Parish Patel in their capacity as former officers (collectively, Officers) of Neumann Medical Center (Neumann), a non-profit corporation, appeal from an order of the Philadelphia County Court of Common Pleas that denied their request for a preliminary injunction. The Officers sought a preliminary injunction to forestall Neumann from prosecuting its claims against them until it advanced their defense costs. ¹ The Officers contend that they are entitled to the advancement of costs for defending themselves in an action brought against them by Neumann under Article VII, Section 1 of Neumann's bylaws.

Initially, we note that Section 5745 of the Nonprofit Corporation Law of 1988 (Nonprofit Law), as amended, 15 Pa.C.S. § 5745 [Advancing Expenses] provides:

Expenses (including attorneys' fees) incurred in defending any action or proceeding referred to in this subchapter may be paid by a nonprofit corporation in advance of the final disposition of the action or proceeding upon receipt of an undertaking by or on behalf of the representative ² to repay the amount if it is ultimately determined that he is not entitled to be indemnified by the corporation as authorized in this subchapter or otherwise. (Footnote added).

Further, a review of Article VII, Section 1 of Neumann's bylaws is obviously in order. That provision states in relevant part:

Each person who ... is made a party ... to or is involved in any action, suit or proceeding (hereinafter a "proceeding") ... including, without limitation, an action or suit by or in the right of the Corporation, by reason of the fact that he or she ... is or was a director or officer of the Corporation or is or was serving at the request of the Corporations [sic] a director or officer of another corporation ... whether the basis of such proceeding is alleged action in an official capacity as director or officer or in any other capacity, shall be indemnified and held harmless by the Corporation to the fullest extent and manner authorized or permitted by the laws of the Commonwealth of Pennsylvania ... against all expense, liability and loss (including attorneys' fees ...) reasonably incurred or suffered by such person in connection therewith and such indemnification shall continue as to a person who has ceased to be a director or officer.... The right to indemnification conferred in this article shall be a contract right and each person to whom this right to indemnification applies shall be a third party beneficiary of such right and shall be entitled to enforce against the Corporation all indemnification and other rights granted to such person by this article.

Such right shall include the right to be paid by the Corporation the expenses incurred in any such proceeding in advance of its final disposition; provided, however, that, if the laws of the Commonwealth of Pennsylvania require, the payment of such expenses incurred by a director or officer in advance of the final disposition of a proceeding shall be made only upon delivery to the Corporation of an undertaking, by or on behalf of such director or officer, to repay all amounts so advanced if it shall ultimately be determined that such director or officer is not entitled to be indemnified under this article or otherwise. (Emphasis added).

Moreover, the pertinent portion of Article VII, Section 4 of Neumann's bylaws affords:

If a claim under Section 1 of this article is not paid in full by the Corporation within thirty (30) days after a written claim has been received by the Corporation, the claimant may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim, and if successful in whole or in part, the claimant shall be entitled to be paid also the expense of prosecuting such claim. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in defending any proceeding in advance of its final disposition where the required undertaking, if any is required, has been tendered to the Corporation) that the Claimant has not met the standards of conduct which make it permissible under the laws of the Commonwealth of Pennsylvania for the Corporation to indemnify the claimant for the amount claimed, but the burden of proving such defense shall be on the Corporation. (Emphasis added).

In short, Neumann's bylaws provide for the mandatory advancement of litigation expenses to an officer or director who, in compliance with the laws of this state, has delivered to the corporation an undertaking to repay the forwarded amounts in the event that he or she is eventually determined not to be entitled to indemnification. Neumann's bylaws also provide that, in a suit brought against it to enforce a claim for advancement of expenses, it cannot assert as a defense a claimant's failure to meet the standards of conduct pursuant to which indemnification is permissible.

Section 5742 of the Nonprofit Law, 15 Pa.C.S. § 5742 [Derivative and corporate actions] states that, if not otherwise restricted in its bylaws, a nonprofit corporation can indemnify its representative or former representative for costs (including attorney's fees) he or she actually and reasonably incurred in defending or settling an action "by or in the right of the corporation" as long as he or she acted in good faith and in the best interests of the corporation. Section 5746(b) of the Nonprofit Law, 15 Pa.C.S. § 5746(b) [Supplementary coverage--when indemnification is not to be made] affords that indemnification is disallowed where the act or omission underlying the indemnification claim is judicially determined to have been willful misconduct or recklessness. By contrast, however, Section 5745 has no standard of conduct requirement as a prerequisite to the advancement of expenses.

In denying the Officer's preliminary injunction request, the trial court relied on Fidelity Federal Savings & Loan Association v. Felicetti, 830 F.Supp. 262 (E.D.Pa.1993) and stated in relevant part "that while the language of Article VII of the Bylaws may make advancement of expenses mandatory, it cannot supersede the overriding duty of the directors to act in the best interest of the corporation." Neal, Callan et al. v. Neumann Medical Center (No. 1045 January Term 1994, filed May 25, 1994), slip op. at 5. ³ The trial court cited Section 512(a) of the Associations Code, 15 Pa.C.S. § 512(a) in support of its rationale, which is the same statutory section that the United States District Court for the Eastern District of Pennsylvania relied on in Felicetti for its decision that the directors' duty to act in a corporation's best interests must take precedence over a corporation's bylaws making advancement of costs mandatory.

Of course, the statutory provision delineating a director's fiduciary duties with respect to a nonprofit corporation is Section 5712(a) of the Nonprofit Law, 15 Pa.C.S. § 5712(a). That section, which is applicable here, matches Section 512(a) of the Associations Code nearly word for word, with the exception that Section 512(a) concerns "domestic" rather than "nonprofit" corporations. The pertinent portion of section 5712(a) provides:

A director of a nonprofit corporation shall stand in a fiduciary relation to the corporation and shall perform his duties as a director ... in good faith, in a manner he reasonably believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances.

Frankly, we do not see how the bylaws providing for the advancement of defense costs to the Officers can reasonably be determined to conflict with this section. There has been no judicial determination that the Officers did not act in good faith or that they engaged in willful misconduct or recklessness, which disposition would necessarily preclude indemnification. Rather, it would appear that Neumann's directors can only act in the corporation's best interests by implementing the mandatory advancement provision, since the bylaws which contain it were presumably adopted for Neumann's benefit. For this reason, we respectfully decline to follow Felicetti.

In addition, since it seems there has been no decision by a Court of this Commonwealth interpreting the precise legal issue before us, the Officers urge us to follow the lead of the courts of other jurisdictions, most specifically, those courts that have interpreted Delaware law, in reaching our decision. The Officers assert that Section 5745 of the Nonprofit Law, which permits the advancement of litigation expenses upon the corporation's receipt of an undertaking, was modelled after Section 145(e) of the Delaware General Corporation Law, Del.Code, Tit. 8, § 145(e), which also allows for the advancement of such costs.

Ridder v. Cityfed Financial Corporation, 47 F.3d 85 (3d Cir.1995), a case decided by the United States Court of Appeals for the Third Circuit, is, in our view, particularly instructive. There, the appellants brought suit against Cityfed Financial Corporation (Cityfed) to obtain advance attorneys' fees for their defense of the underlying action in which they had been sued by Resolution Trust Corporation, Cityfed's receiver, for certain frauds and breaches of fiduciary duty.

The Court of Appeals stated in relevant part in Ridder:

The issue before the district court was not whether appellants were likely to prevail in the [Resolution Trust Corporation] litigation, but whether they were likely to prevail in their...