On October 12, 2011, the California Court of Appeals held in
Nicholas Laboratories v. Chen that employers who lose suits they initiated against an employee related to the employee’s official duties, are not required to pay the employee’s attorney fees pursuant to California Labor Code §2802(a). The Court also held that California Corporations Code §317(d) does not apply to Limited Liability Corporations (LLC), and LLCs are, therefore not required to indemnify employees.
Nicholas Labs filed suit against Chen asserting various causes
of action including theft, breach of contract, and diversion of business
opportunities. While Nicholas Labs ultimately dismissed its complaint without prejudice, Chen filed a cross-complaint claiming that since the cause of action related to his service as an employee, Nicholas Labs was required by California Labor Code §2802(a) and Corporations Code §317 to indemnify Chen for the $89,000 in attorney fees he “necessarily” incurred successfully defending his suit.
§2802(a), states: “An employer shall indemnify his or her employee
for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties, or of his or her obedience to the directions of the employer, even though unlawful, unless the employee, at the time of obeying the directions, believed them to be unlawful.”
While noting that it was charting new territory, the Court of Appeals held that the California legislature did meant for the word “indemnify” to apply to third party actions against the employee, rather than “first party” disputes between the employer and employee. The Court reasoned that
because the Legislature had omitted a provision specifically providing attorney fees to employees incurred defending an action by the employer “any interpretation which would allow the statute to become a unilateral attorney fee statute in litigation between employees and employers would be incompatible with California’s larger body of law.” In essence, this ruling solidifies the American Rule which requires each party to a law suit to pay his own legal expenses in the absence of statutory or contractual obligations.