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No. 102,579 IN THE COURT OF APPEALS OF THE STATE OF KANSAS WESTAR ENERGY, INC., Appellant/Cross-appellee, v. DAVID C. WITTIG, Appellee/Cross-appellant. SYLLABUS BY THE COURT

1. K.S.A. 17-6305 permits a corporation to indemnify its officers and directors for all costs associated with any civil, criminal, administrative proceeding, or investigation arising from their position in the corporation.

2. A corporation may advance expenses reasonably incurred for all costs by officers and directors under K.S.A. 17-6305, including attorney fees, before the underlying investigation or legal action ends. But first the officer or director must sign an agreement to repay the corporation for any advances made on his or her behalf, in case the parties later decide the officer or director is not entitled to indemnity.

3. By contract, a corporation can make indemnity and advancement mandatory for its officers and directors.

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4. The right to corporate indemnity cannot be determined until the underlying investigation or action has concluded.

5. The right of an officer or director of a corporation to be indemnified by the corporation and the right to receive advances of defense fees and expenses are distinct.

6. A court proceeding to determine advancements is a determination of the officer's or director's entitlement to the advances and the reasonableness of the requested fees and expenses. The burden is upon the party seeking advances to prove their reasonableness. The proceeding must be summary in nature in order to provide immediate interim relief for the officer or director entitled to such advances.

7. Any attempt by a corporation to recover funds already advanced to an officer or director must come after indemnity is determined. Only then can the competing rights of the parties be assessed.

8. District judges are experts on attorney fees and must use Kansas Rule of Professional Conduct 1.5(a) (2009 Kan. Ct. R. Annot. 460) as the methodology to assess the reasonableness of any request for attorney fees, including such fees requested in a corporate advancement proceeding.

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9. An appellate court will review an award of attorney fees with an abuse of discretion standard.

Appeal from Shawnee District Court; DAVID E. BRUNS, judge. Opinion filed July 9, 2010. Affirmed; cross-appeal denied.

Charles W. German, Kirk T. May, and Jason M. Hans, of Rouse Hendricks German May PC, of Kansas City, Missouri, for appellant/cross-appellee Westar Energy, Inc.

Jeffrey D. Morris, Jeremy S. Weis, Nick J. Kurt, and Kirk A. Peterson, of Berkowitz Oliver Williams Shaw & Eisenbrandt, LLP, of Kansas City, Missouri, for appellee/cross-appellant David C. Wittig.

Before HILL, P.J., GREEN and STANDRIDGE, JJ.

HILL, J.:

Introduction

This appeal involves a declaratory judgment action between a corporation and one of its former officers. Westar Energy, Inc. agreed to advance attorney fees and expenses reasonably incurred by any of its officers charged with a crime that related to that officer's employment. David C. Wittig, a former officer of Westar, was charged in federal court with crimes arising from his conduct during his time as an officer of Westar. Westar is now responsible for advancing fees and expenses reasonably incurred in Wittig's defense.

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Persuaded by cases from Delaware, an historical source of corporate law in Kansas, we hold that Westar must reserve any action seeking recoupment, such as setoff, until after it is determined whether Wittig must pay any of the money advanced back to Westar. To rule otherwise would destroy the right of advancement entirely and thus rewrite the parties' contract, something a court cannot do. Therefore, we uphold the district court's denial of declaratory relief to Westar on this point.

Finally, a district judge in Kansas is considered an expert on attorney fees and must use the factors found in Kansas Rule of Professional Conduct 1.5(a) (2009 Kan. Ct. R. Annot. 460) to measure the reasonableness of an attorney fee request. Here, after taking testimony on the subject and methodically considering all eight factors in Rule 1.5(a), the district court determined that the fees requested by Wittig for a Washington, D.C. law firm were unreasonable and lowered the hourly rate that Westar is to advance in Wittig's defense. The two questions that must be answered by a court in an advancement action are the entitlement of the officer to the advancement and the reasonableness of the fees and expenses requested. There is no dispute that Wittig is entitled to advancement. Even so, the district court here was obliged to determine the reasonableness of the fees Wittig requested. Because the findings of the district court were supported by substantial competent evidence, we find no abuse of discretion on this point and uphold the district court's ruling. Therefore, we deny Wittig's cross-appeal.

We give a brief review of the facts.

In December 2003, a federal grand jury indicted David C. Wittig for allegedly defrauding Westar Energy, Inc., a Kansas corporation. The United States began his prosecution for the crimes alleged in the indictment in United States v. Wittig and Lake, 03-40142-JAR, a case that is awaiting a new (third trial). When he was indicted, Wittig

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was the former Chief Executive Officer and Chairman of the Board of Directors of Westar. Wittig hired two law firms to help in his defense, Piper Rudnick, LLP from Washington, D.C. and Berkowitz, Oliver, Williams, Shaw & Eisenbrandt, from Kansas City, Missouri. For purposes of brevity, we will refer to the Washington, D.C. law firm as Piper Rudnick and the Kansas City, Missouri, law firm as Berkowitz Oliver. We must point out that this prosecution was not the only legal problem Wittig was experiencing at the time, because in an unrelated case, in November 2002, he was indicted for bank fraud. In that prosecution, Wittig retained James L. Eisenbrandt of the Berkowitz Oliver firm as his defense counsel. Therefore, Wittig had already established a client-attorney relationship with Berkowitz Oliver before his second indictment.

As his prosecution continued, Wittig's legal bills mounted and he sought advances from Westar to cover these expenses. He based these claims on Article XVIII (2)(a) of Westar's Articles of Incorporation. In his view, that article amounted to a contract, a view not disputed by Westar.

"Each person who was or is made a party . . . to or is involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative . . . by reason of the fact that he or she . . . is or was a director or officer, of the Corporation . . . shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Kansas General Corporation Law . . . against all expense, liability and loss (including attorneys' fees . . .) reasonably incurred or suffered by such person in connection therewith . . . . The right to indemnification . . . shall be a contract right and shall include the right to be paid by the Corporation the expenses incurred in defending any such proceeding in advance of its final disposition: provided, however, that, if the Kansas General Corporation Law requires, the payment of such expenses . . . in advance of the final disposition of a proceeding, shall be made only upon delivery to the Corporation of an undertaking . . . to repay all amounts so advanced if it shall ultimately be determined

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that such director or officer is not entitled to be indemnified under this Section or otherwise."

Therefore, Wittig signed and delivered to Westar the following "Undertaking":

"I, David C. Wittig, hereby agree that I will immediately repay Westar Energy, Inc. ("Westar") any payment it has advanced to me to cover my reasonable attorney's fees and other expenses in connection with cases brought against me . . . in the event it is ultimately determined . . . that I am not entitled to be indemnified by Westar. . . ."

In response to the "Undertaking," Westar paid all accrued bills to Piper Rudnick in September 2004. But that was just the beginning.

Again, in September and October 2004, Westar received a second and third round of Piper Rudnick bills. Westar did not review them but paid the bills in October and December 2004. But that did not end the matter. Soon after the next billing, Westar's counsel sent a letter in March 2005 telling Piper Rudnick that its bills were unreasonable and Westar did not want to advance further fees to the firm. By this time, Westar had paid a little more than $1.8 million to Piper Rudnick. Nonetheless, the parties explored a possibility of compromise.

Instead of going to court, Westar and Wittig settled the matter. Westar agreed to pay all Piper Rudnick bills for legal services through January 2005. Both parties agreed to not go to court over these bills and, in return, Wittig would give up his rights to any Westar assets if he was convicted. However, Westar made it clear it was not waiving any right the company had to challenge the reasonableness of any future Piper Rudnick bills:

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"Therefore, and without conceding that any of the fees or expenses incurred are reasonable, the Company will advance unpaid legal fees and expenses to Mr. Wittig for your bills through January 31, 2005. Furthermore, the Company expressly reserves all of its rights to object to any future advancements requested by Mr. Wittig on any grounds, including the reasonableness of the bills, and Mr. Wittig agrees that any advancements toward his legal fees and expenses in the criminal case that have been made or may be made in the future by Westar shall not be considered a waiver of Westar's right to challenge the reasonableness of such legal fees and expenses in the future for purposes of advancement or indemnification."

After that, Westar paid more than $1.5 million in Piper Rudnick fees. But Wittig's legal expenses kept mounting.

Westar sues Wittig for declaratory judgment and breach of contract.

After advancing more than $3.6 million for legal fees, Westar sought relief in Shawnee County District Court. In this declaratory judgment action, Westar wanted the district court to decide the reasonableness of the fees and expenses that Wittig wanted them to advance. In a second count, Westar brought a breach of contract claim against Wittig, alleging the fees and expenses the company had already advanced were unreasonable and, therefore, Wittig had breached their contract.

The district court was thorough in its handling of this case. First, the court appointed Jack Focht, a respected member of the Wichita bar, to act as Special Master under K.S.A. 60-253(c). The district court reasoned that Focht, who has extensive experience in defending those accused of white-collar crimes, could use his experience to sort out the many questions arising from the extensive documentation associated with the legal bills from both firms. The court directed Focht to review all the legal fees and

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expenses using the factors set up by Kansas Rule of Professional Conduct (KRPC) 1.5(a). Focht diligently tackled the job and reported to the court in November 2007.

Focht advised the court that the fees Wittig sought for advancement were reasonable. Focht considered all the factors found in KRPC 1.5(a) in making his report to the court. (However, he did advise certain expenses claimed by Piper Rudnick were not reasonable. Those amounts are not relevant to this appeal.) Both parties objected to Focht's conclusions.

So, the district court accepted added documentation from both sides in support of their positions. And, in March 2008 it entertained additional evidence on the matter through the testimony of James L. Eisenbrandt, one of the senior partners in the Berkowitz Oliver firm. After considering the matter for some time, the court issued a declaratory judgment in July 2008.

The district court grants Westar a part of what it wanted.

In granting declaratory relief to Westar, the district court decided Westar had agreed to advance "reasonable fees," not "all fees." Then, the court, focusing on bills incurred between February 2005 and June 2005, ruled the number of hours and the hourly rates charged by Berkowitz Oliver were reasonable and Westar should advance them to Wittig. Going further, the court declared the hours billed by Piper Rudnick were reasonable, but their hourly rates were not. Therefore, the court declared Westar should advance fees to Wittig at a lower hourly rate for Piper Rudnick. (The court reduced some expenses sought by Piper Rudnick, but they are not part of this appeal.) The court moved on then to the breach of contract claim brought by Westar.

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After granting relief to Westar on the issue of advancement of the Piper Rudnick bills, the district court decided a breach of contract claim for bills already paid by Westar was premature. The court reasoned that because an advancement action is forwardlooking, thus insuring a defense, and the policy of corporate indemnification, which means the alleged wrongdoer may or may not have to repay, the remedy for any unreasonable charges already paid should come later:

"Since this is an advancement action, the Court finds that it would be premature to determine whether David Wittig will ultimately be entitled to indemnification from Westar Energy, Inc. Likewise, the Court finds that it would be premature to determine whether Westar is entitled to recoupment or an offset for the legal fees and expenses which the corporation has previously advanced on behalf of Mr. Wittig. Rather, the Court finds that these issues can only be determined after the underlying criminal case has been finally resolved."

After making this ruling, the court asked the parties to confer about the issue of fees already paid. Because the parties could not settle the matter, the court made its ruling.

On this point, the court ruled that any breach of contract remedies such as "recoupment" or "setoff" for fees and expenses already paid by Westar could not be resolved until after the criminal case against Wittig ends. So, the court dismissed Westar's breach of contract claim against Wittig.

Since the district court's ruling, we have been told at oral argument that fees and expenses are still flowing from Westar to Wittig, but at the adjusted rates. No one has any idea when the criminal case against Wittig will end.

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Here is a brief review of corporate indemnity and advancement law.

With the passage of K.S.A. 17-6305, the Kansas Legislature created a public policy to encourage worthy individuals to accept positions of responsibility with corporations as directors and officers. By providing those officers indemnity from the costs associated with civil, criminal, and administrative actions as well as investigations, such officers and directors are free to make good-faith decisions without fear of penalty. The expenses that are refundable under this law are those incurred from a legal action taken against an officer or director because that person is or was a director, officer, employee, or agent of the corporation. See K.S.A. 17-6305(a). Concurrent with indemnity is the right of advancement.

Advancement of expenses, including attorney fees, incurred by a director or officer in defending a civil, criminal, administrative, or investigative action is sanctioned by K.S.A. 17-6305(e). The corporation may pay those expenses before the legal action involving the director or officer ends. But before any such advance is made, the officer or director must give the corporation an "undertaking" to repay any advances made on his or her behalf if it is later determined that officer or director is not entitled to indemnity. The statute does not allow the corporation to decide first the merits of the director's or officer's defense before advancing the costs. Chiefly, the advances are a separate right that must be honored by the corporation. Besides these discretionary statutory rights of indemnity and advancement, corporations may, by contract, offer mandatory rights of indemnity and advancement.

Such a mandatory right was created here by Westar in Article XVIII(2)(a) of its Articles of Incorporation. Therefore, Wittig is entitled to advancement of attorney fees and expenses reasonably incurred by him in his prosecution. Clearly, K.S.A. 17-6305(f)

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allows a corporation to make an agreement for both indemnity and advancement. Therefore, we must interpret this contract between Westar and Wittig. But we do not do so in a vacuum. Although there are no Kansas cases reported on the subject, we turn to the reports from Delaware courts because Delaware is the wellspring of Kansas corporate law. Our Supreme Court has a long history of looking to Delaware for guidance when applying the Kansas General Corporation Code. See Kansas Heart Hospital v. Idbeis, 286 Kan. 183, 197, 184 P.3d 866 (2008). A review of Delaware cases dealing with indemnity and advancement issues is informative.

First, we examine Homestore, Inc. v. Tafeen, 888 A.2d 204 (Del. 2005). In Homestore, a former corporate officer, Tafeen, sued for advancement of expenses and attorney fees arising from several civil lawsuits and an investigation by the Securities and Exchange Commission and the Department of Justice. The Delaware Supreme Court explained, "[i]ndemnification encourages corporate service by capable individuals by protecting their personal financial resources from depletion by the expenses they incur during an investigation or litigation that results by reason of that service." 888 A.2d at 211. The court went on to point out that, "[t]he right to indemnification cannot be established, however, until after the defense to legal proceedings has been 'successful on the merits or otherwise.'" 888 A.2d at 211. But the court carefully contrasted advancements.

Advancement, according to the Delaware Supreme Court in Homestore, "is an especially important corollary to indemnification as an inducement for attracting capable individuals into corporate service. Advancement provides corporate officials with immediate interim relief from the personal out-of-pocket financial burden of paying the significant on-going expenses inevitably involved with investigations and legal proceedings." 888 A.2d at 211. Even though advancement and indemnification are

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corollary, under Delaware law they involve separate and distinct legal actions. The right to advancement is not dependent on the right to indemnification. 888 A.2d at 212. In fact, "[t]he limited and narrow focus of an advancement proceeding precludes litigation of the merits of entitlement to indemnification for defending one self in the underlying proceedings." 888 A.2d at 214.

Next, in Citadel Holding Corp. v. Roven, 603 A.2d 818 (Del. 1992), the Delaware Supreme Court ruled, in a case involving an agreement similar to the contract found in Westar's Articles of Incorporation and involving a statute from Delaware's general corporation law identical with the Kansas advancement statute, "the corporation's obligation to pay expenses is subject to a reasonableness requirement." 603 A.2d at 823. The corporation in Citadel was not required to advance unreasonable expenses but was required to advance reasonable ones. 603 A.2d at 823-24. A right to advancement is not a corporate blank check. See also Fasciana v. Electronic Data Systems Corp., 829 A.2d 160, 175 (Del. Ch. 2003) (an advancement is best thought of as a credit advanced to a director of a corporation). Also, the Supreme Court of Delaware ruled the burden of proving the reasonableness of the charges is on the officer seeking advancements. Citadel, 603 A.2d at 825.

After that, we examine the ruling of the Chancery Court of Delaware in Sun-Times Media Group, Inc. v. Black, 954 A.2d 380 (Del. Ch. 2008). After advancing more than $77 million to the defendants over 5 years (including $60 million for criminal defense fees and expenses), Sun-Times brought an action to foreclose any further advancements and also sought to recoup some of the funds already advanced. The defendants had been convicted of some of the crimes charged, and the criminal cases were working their way through the federal appeals courts. The Chancery Court decided that indemnity can only be determined after the final disposition of the underlying case (or cases). Therefore, in

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the criminal context, an appeal of a conviction is a final shot at defeating the prosecution. 954 A.2d at 398 n.69. The corporation was contractually obliged to continue to advance fees and expenses until the last nonappealable order was issued in the underlying case. As a result, Sun-Times could not evade its contractual responsibility to advance attorneys fees and expenses connected with the former officers' criminal appeals. Finally, the court dismissed the two counts filed by Sun-Times seeking repayment or setoff. The court stated, "Performing such an allocation analysis on a provisional basis could turn out to be [a] waste of the parties' and the court's resources if the criminal convictions are overturned. If that happens, an allocation would be unnecessary. [Those Counts] are dismissed as not yet ripe." 954 A.2d at 409.

Finally, the Delaware Supreme Court held in Kaung v. Cole Nat. Corp., 884 A.2d 500, 509 (Del. 2005), the scope of an advancement action made under the general corporation law of Delaware is limited to the issue of entitlement and not to issues about the alleged wrongdoer's conduct in the underlying litigation. Again, the court stressed that an advancement action is a summary proceeding. Then, in Kaung, the Supreme Court ruled the Chancery Court appropriately determined that some of the time billed was not reasonably incurred and therefore the corporation need not make advancements for the unreasonable bills. But, in the Supreme Court's view, the Chancery Court went too far when it "prematurely decided Kaung's liability for sums previously advanced" by the corporation were unreasonable requests and the former officer was liable for their repayment. Put simply, the court stated, "[We] hold that an advancement proceeding is summary in nature and not appropriate for litigating indemnification or recoupment. The detailed analysis required of such claims is both premature and inconsistent with the purpose of a summary proceeding." 884 A.2d at 510.

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To summarize, Delaware cases provide useful instruction on the law of indemnity of corporate officers and directors and the law of advancement of defense expenses and attorney fees. First, even though they are corollary rights, indemnity and advancement are not identical. In fact, advancement is independent of indemnity and--by contract--a corporation may grant a greater right of advancement than indemnity. Second, advancement proceedings should be summary in nature, with the court deciding whether a corporation should make reasonable advancements because the underlying legal action (or investigation) arises from the person's corporate actions. Advancement is not a corporate blank check. The burden of proving the reasonableness of the expenses rests with the party seeking advancements. Swift resolution of these questions preserves the right of advancement. Finally, a day of reckoning will come. Either the parties or a court must decide if the person receiving the advancements must repay or not. But that day will come only after the final nonappealable action is taken in the underlying legal action or investigation. Until that time, the corporation must make reasonable advancement of expenses and legal fees. Essentially, an advancement action is a determination of entitlement and reasonableness. These precepts are reasonable and persuasive and we will apply them to this appeal.

We state our standards of review about the partial denial of declaratory relief.

We will use two standards of review while deciding this appeal. For the question of the district court denying declaratory judgment, we will employ an abuse of discretion standard, and a de novo standard when interpreting the parties' contract. Our reasons for using both standards follow.

In this case, the district court refused to make a declaratory judgment on the reasonableness of legal fees and expenses already advanced by Westar because that

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determination was "premature." The denial of such relief for being premature is consistent with fundamental principles of declaratory judgment law because declaratory relief is only available when there is an actual controversy between the parties. See In re Estate of Keller, 273 Kan. 981, 984-85, 46 P.3d 1135 (2002). An actual controversy exists when the parties can assert rights that have developed or will arise against each other. And, one of the four requirements for a declaratory judgment action is that the issue to be determined must be ripe for judgment. See State ex rel. Morrison v. Sebelius, 285 Kan. 875, 896-97, 179 P.3d 366 (2008).

Whether this issue was ripe for judgment is the basic question in this appeal. We must decide then whether the district court erred by holding a part of Westar's claim was not ripe for judgment. We review such questions for an abuse of discretion. See T.S.I. Holdings, Inc. v. Jenkins, 260 Kan. 703, 721-22, 924 P.2d 1239 (1996). A court abuses its discretion when judicial action is arbitrary, fanciful, or unreasonable. State v. Reed, 282 Kan. 272, 280, 144 P.3d 677 (2006). Further, an abuse of discretion standard includes a review to discover if the discretion was guided by any erroneous conclusions of law. See State v. Skolaut, 286 Kan. 219, Syl.

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