Arthur S. KATAYAMA, Cross-Complainant and Appellant, v. INTERPACIFIC PROPERTIES, INC., Cross-Defendant and Respondent.
Does the Corporations Code require a corporate plaintiff to indemnify its former lawyer for his costs and attorneys fees after he prevailed in an action it brought against him for legal malpractice? We hold it does and that the corporation may not limit its liability to the deductible amount of the attorney's malpractice coverage.
Interpacific Properties, Inc. sued Arthur S. Katayama for legal malpractice, claiming he entered into an unauthorized settlement of a multi-million dollar lawsuit on behalf of the corporation. Katayama cross-complained for approximately $12,000 in attorneys fees for his representation of Interpacific in the underlying litigation and for indemnity for the expenses, including legal fees, he would incur in defense of the malpractice suit. The latter claim was made under Corporations Code section 317, subdivisions (c) and (d).
The malpractice action was tried first and Interpacific lost.1 Trial on the cross-complaint followed, and the court awarded Katayama $12,637.76 on his cause of action for fees earned while serving as Interpacific's counsel. The court further found Katayama was an agent of the corporation within the meaning of Corporations Code section 317, subdivision (a), that he was successful in his defense of the action brought by the corporation, and that he reasonably incurred expenses, including attorneys fees, in the sum of $137,041.21 to defend the malpractice action.
Nevertheless, the court concluded that Corporations Code section 317, subdivision (d) “was intended and applies to the situation where an agent of a corporation successfully defends against an action by a third party or against a derivative action by the corporation, and that it does not apply to the situation where, as in the present case, the corporation in a non-derivative type proceeding sues its agent, even if the agent prevails in the action.” Judgment was entered for Interpacific on Katayama's cause of action for indemnification under the Corporations Code. Katayama appeals from that portion of the judgment.
The Legislature added section 317 to the Corporations Code in 1975, effective January 1, 1977. (Stats.1975, ch. 682, § 7, p. 1541.) It was based on language in the A.B.A. Model Business Corporations Act, section 5, and is virtually identical to corresponding legislation in New York, Delaware, Ohio, and other states. Subdivision (a) of section 317 furnishes definitions for various terms. For example, “agent” is defined as anyone who has served a corporation in the capacity of “director, officer, employee or other agent․” And “ ‘proceeding’ means any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative․” “Expenses” include attorneys fees and all costs reasonably incurred to establish the right to indemnification. Subdivision (b) provides for indemnification of any agent who is or is threatened to be a party to any proceeding other than one “by or in the right of the corporation․” Traditionally, this has meant corporate agents may seek indemnification for third-party civil actions and criminal prosecutions.
Subdivision (c) provides, “A corporation shall have power to indemnify any person who was or is a party ․ to any [ ] pending or completed action by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person is or was an agent of the corporation, against expenses actually and reasonably incurred by such person in connection with the defense or settlement of such action if such person acted in good faith․” (Emphasis added.) Subdivision (d) mandates indemnification of the agent “[t]o the extent [he] has been successful on the merits in defense of any proceeding referred to in subdivision (b) or (c)․”
The language in section 317, subdivisions (c) and (d) is straightforward and unambiguous; and its literal terms require indemnification of an attorney who successfully defends a legal malpractice action brought by a former corporate client. Nevertheless, we recognize that commentators invariably discuss subdivision (c) only as it relates to derivative actions, as that term is used in the corporate context, i.e., a lawsuit by one or more shareholders on behalf of the corporation. (See, e.g., 1 Marsh, Marsh's Cal.Corporation Law (2d ed. 1985 Supp.) Executive Compensation, § 9.36, pp. 536–537; 1 Ballantine & Sterling, Cal.Corporation Laws (4th ed. 1985) Indemnification and Insurance, § 109.01, p. 6–39; Heyler, Indemnification of Corporate Agents (1976) 23 U.C.L.A.L.Rev. 1255, 1257, 1259–1261.) Interpacific attempts to put its own lyrics to the melody of these articles. It argues subdivision (c) must only apply when the corporation and agent are on the “same side of the litigation,” e.g., when disgruntled minority shareholders sue, or when the corporation sues a third party who in turn cross-complains against the agent. (Fed-Mart Corp. v. Pell Enterprises, Inc. (1980) 111 Cal.App.3d 215, 218–219, 168 Cal.Rptr. 525.)
In support of its contention Interpacific suggests there is nothing in the predecessor statute, former Corporations Code section 830, to lend support to Katayama's “distort[ed]” interpretation of section 317. Not so. Former section 830 provided in part, “(a) When a person is sued, either alone or with others, because he is or was a director, officer, or employee of a corporation, [ ] in any proceeding arising out of his alleged misfeasance or nonfeasance in the performance of his duties or out of any alleged wrongful act against the corporation or by the corporation, indemnity for his reasonable expenses, including attorneys' fees incurred in the defense of the proceeding, may be assessed against the corporation, [ ] by the court in the same or a separate proceeding, if both of the following conditions exist: [¶] (1) The person sued is successful in whole or in part, or the proceeding against him is settled with the approval of the court. [¶] (2) The court finds that his conduct fairly and equitably merits such indemnity.
“(d) This section applies to all proceedings specified in subdivision (a), whether brought by the corporation, its receiver, its trustee, one or more of its shareholders or creditors, any governmental body, any public official, or any private person or corporation, domestic or foreign․” (Emphasis added.)
We have located only one California appellate opinion discussing an agent's right to indemnification for successfully defending a direct action by the corporation under former section 830, and it is of no assistance to Interpacific. In New Capital for Small Businesses, Inc. v. Saunders (1963) 215 Cal.App.2d 728, 30 Cal.Rptr. 563, a corporation obtained a judgment against its attorney, who was also a director, on a common count for money had and received based on unauthorized payments to himself of commissions from the sale of corporate stock. Notwithstanding the corporation's success, the attorney sought indemnification under section 830. The court dismissed his contention because he was not the successful party, but the opinion never suggests an agent who prevails in a direct action by the corporation could not recover his fees.
Case law interpreting the current statute and its out-of-state cousins is sparse, and there is none to our knowledge from California courts. But we have located two opinions from other jurisdictions, and they support Katayama's position. In Professional Insurance Company of N.Y. v. Barry (1969) 60 Misc.2d 424, 303 N.Y.S.2d 556, a corporation sued a former director for breach of fiduciary duty. He cross-complained for indemnity under the applicable New York statute, Business Corporation Law, section 722, which is similar to our section 317. The opinion is not clear on the point, but the director apparently undertook his relationship with Professional at the request of another corporation, Schapiro & Co., Inc. The court conceded he was entitled to indemnification from Professional if he prevailed and met the other requisites of the statute (id., 303 N.Y.S.2d at p. 560) and concluded he might be entitled to indemnification from Schapiro as well.
In Lawson v. Young (1984) 21 Ohio App.3d 190, 486 N.E.2d 1177, the receiver for an insolvent corporation sued the directors for fraud. The directors prevailed; but the trial court refused to award attorneys fees under Revised Code 1701.13(E)(3), which is identical to our statute. The appellate court reversed, observing, “Clearly, had [the corporation] brought the action against [the directors] alleging fraud and mismanagement ․ and had [the directors] successfully defended such an action, [the corporation] would have been obligated pursuant to R.C. 1701.13(E)(3) to indemnify [the directors] for their expenses incurred in the successful defense of such an action.” (Id., 486 N.E.2d at p. 1179.)
We see no logical reason to view Katayama's position any differently. Corporations may be treated as persons under the law in general, but they are creatures of statute and subject to a wide range of rules and obligations not imposed on individuals. In the context of litigation expenses, a rationale for disparate treatment is not difficult to divine. Corporations may only operate through agents by their very nature, and they are frequently wealthy and able to pursue prolonged and complex litigation that few individuals could afford to defend. And a direct suit by a corporation is no less costly to defend than the same claim brought as a derivative action by minority shareholders. In the latter situation, of course, the successful agent is unquestionably entitled to indemnification. Thus, we see nothing in the statute itself, or the apparent policy behind it, supportive of Interpacific's argument.
Katayama's legal malpractice insurer retained an attorney who represented him both in his capacity as a defendant and cross-complainant. The reasonable expenses for the defense of the main action alone totaled $137,041.21, according to the trial court's findings. Of this sum, however, Katayama's out-of-pocket expenses were only $1,000, his deductible under the malpractice policy. Interpacific's final contention is that if it must indemnify Katayama, it is responsible only for that $1,000. Again we disagree.
A similar argument was rejected by Division One of this court in Fed-Mart Corp. v. Pell Enterprises, Inc., supra, 111 Cal.App.3d 215, 168 Cal.Rptr. 525. There, the trial judge determined the corporation's former president, Sol Price, was entitled to indemnification from Fed-Mart and ordered the corporation to pay him $73,500. Price had “an informal” fee arrangement with his counsel: “[T]he attorney would be entitled to receive fees only after Price's right to indemnification had been established by the court. The amount of attorney fees was to be whatever the trial court determined to be ‘reasonable’․” (Id., at p. 228, 168 Cal.Rptr. 525.) Based on this understanding, Price actually paid $50,000 to his lawyers during the course of the litigation. On appeal Fed-Mart launched a two-pronged attack on the award: First, it argued its obligation to indemnify should be limited to Price's out-of-pocket expenses. Second, Fed-Mart contended the arrangement constituted a contingent fee agreement which was “not subject to indemnification under section 317 because the fees were not ‘actually incurred.’ ” (Id., at p. 229, 168 Cal.Rptr. 525.)
The Court of Appeal disagreed: “Fed-Mart's argument assaults a straw man. The trial court determined ․ what legal expenses were actually incurred and their reasonableness. The court's assessment was based upon statutory duties imposed on Fed-Mart and the court, not upon any arrangement, contingent or otherwise, existing between Price and his attorney.” (Ibid., emphasis added.) The same logic applies in this situation as well.
Under section 317, subdivision (d) the successful agent is entitled to “be indemnified against expenses actually and reasonably incurred by the agent․” Actual payment by the agent is not a prerequisite to the right to indemnification. Katayama reasonably incurred legal expenses of $137,041.21 in order to defend Interpacific's complaint. That his legal malpractice insurer was obligated, pursuant to a wholly unrelated contract, to assume the financial burden of providing his defense does not alter the fact that the expenses were actually incurred or that Interpacific had a statutory obligation to pay them.2 In other words, having lost on the merits, Interpacific is not entitled to be treated as a third-party beneficiary of Katayama's policy. (See also Staples v. Hoefke (1987) 189 Cal.App.3d 1397, 1410, 235 Cal.Rptr. 165, where the Court of Appeal affirmed an award of attorneys fees under Civ.Code, § 1717: “Plaintiffs were not entitled to avoid their contractual obligation to pay reasonable attorney fees based on the fortuitous circumstance that they sued a defendant who obtained insurance coverage providing a defense.”)
Judgment reversed. Appellant is entitled to costs on appeal, including attorneys fees, to be determined on remand by the trial court.
1. Interpacific may have a decent malpractice action now. It noticed an appeal from the judgment in the main action, but it was twice dismissed for its counsel's failure to follow required procedures and twice reinstated upon his application. The appeal was finally dismissed on March 28, 1985, for failure to deposit costs for the preparation of the appellate record. (Cal.Rules of Court, rule 10(c).) We rejected a third motion to revive the appeal many months later brought by Interpacific's current attorneys who were not involved in the matter previously.
2. We note that Katayama does not stand to enjoy a windfall. Any reimbursement he receives, according to his counsel's undisputed representations, is payable to his insurer. The expenses were incurred because of Interpacific's conduct and were entirely beyond the carrier's control. Thus, as between Interpacific and the insurer, it makes perfect sense that Interpacific bear the cost.
CROSBY, Associate Justice.
TROTTER, P.J., and SONENSHINE, J., concur.