Employer Need Not Indemnify Former Employee For Expenses Incurred In Defending Suit Filed By The Employer

California Labor Code section 2802 generally requires an employer to indemnify an employee who is sued for conduct in the course and scope of employment, including the payment of costs and fees incurred in defending the action. Does this mean that a California employer must reimburse a former employee for the employee's costs in successfully defending a lawsuit filed by the employer against the employee? On October 12, 2011, in Nicholas Laboratories, LLC v. Christopher Chen, the California Court of Appeal ruled that an employer has no duty of indemnification under these circumstances.

Employer's Complaint Against The Employee

The employer, Nicholas Laboratories, sued its former Director of IT Christopher Chen, alleging that during his employment Chen engaged in a business that made him a competitor of the company, diverted business opportunities away from the company, and stole or misused company property. Chen filed a cross-complaint, seeking indemnity under Section 2802 for expenses and attorney fees incurred in defending claims relating to his service as an employee of Nicholas. On the eve of trial, Nicholas dismissed its complaint against Chen in return for an agreement that Chen would submit his cross-complaint for indemnity to a bench trial based on written submissions. The trial court rejected Chen's cross-complaint, finding that Section 2802 did not apply to first-party claims. Chen appealed and the Court of Appeal affirmed.

Labor Code Section 2802 Does Not Extend To First-Party Claims

Section 2802 provides, in relevant part, "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."

The Court of Appeal noted that the common meaning of the word "indemnify" in the context of litigation is "an obligation to pay for judgments suffered and/or expenses incurred in a lawsuit brought by a third party against the indemnitee, not a one-sided attorney fee provision in a dispute between the indemnitor and the indemnitee." The court reviewed the language of Section 2802 and determined that the Legislature did not intend to depart from this common meaning of "indemnify."

Supporting the court's conclusion were the following points: (1) an employer has a right to sue an employee under various theories; (2) the default rule in California is that parties pay their own attorneys' fees unless specifically provided by statute or contract; (3) contract provisions attempting to authorize unilateral attorneys' fees awards must be interpreted to authorize fees to the prevailing party; (4) statutes have specific provisions authorizing fees in certain employer-employee litigation; (5) Code of Civil Procedure section 128.7 authorizes a court to award attorneys' fees as a sanction under some circumstances; (6) remedies such as abuse of process and malicious prosecution exist for dealing with improper litigation; and (7) the Legislature knows how to depart from the ordinary meaning of indemnify to include first-party claims if it intends to do so.

Based upon a consideration of these points, the Court of Appeal determined that the Legislature did not intend to depart from the common meaning of "indemnify" when it enacted Section 2802. In other words, absent other contractual or statutory support, Section 2802 does not require an employer to reimburse an employee for attorneys' fees incurred in the employee's successful defense of an employer's action against the employee.

What Nicholas Laboratories Means For Employers

Although employers must continue to indemnify employees and former employees for litigation costs arising out of a claim based on an employee's actions within the course and scope of employment, employers generally will not be required to indemnify those costs if it is the party suing the employee.

By: Fred Sanderson and Rupa Shah

Fred Sanderson is a partner in Seyfarth's Sacramento office and Rupa Shah is a Staff Attorney in Seyfarth's San Francisco office. If you would like further information, please contact your Seyfarth Shaw LLP attorney, or Fred Sanderson at asanderson@seyfarth.com or Rupa Shah at rshah@seyfarth.com.