22 November 2021

No Strict Liability for Improper Share Repurchases or Payment of Dividends: Directors Are “Fully Protected” if They Rely in Good Faith upon Corporate Records, Officers, or Experts

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In re the Chemours Company Derivative Litigation, Vice Chancellor Glasscock recently wrestled with an apparent conflict between two provisions of the Delaware General Corporation Law (DGCL)—and chose the path that protects directors. Vice Chancellor Glasscock refused to hold directors strictly liable for negligent stock repurchases or dividends—which would be inconsistent with Delaware’s general limitation on director liability solely to damages for gross negligence (unless exculpated) or loyalty breaches—and instead enforced an “incongruent” provision that accords directors protection where they rely on corporate records, officers, or experts with respect to corporate surplus available to repurchase shares or issue dividends.

Stockholders of Chemours Company alleged that stock repurchases and dividends should not have been paid because Chemours Company faced massive environmental liabilities—not recorded under GAAP—such that it had no corporate surplus and was in fact insolvent or “teetering on insolvency” at the time of the distributions. Even though Plaintiffs themselves had received the dividends, they sought under Section 174 of the DGCL to hold the directors strictly liable to repay to the corporation amounts distributed for stock repurchases and dividends. Plaintiffs alleged that the Director Defendants were at least negligent by relying on GAAP-based accounting (which, they alleged, did not require reserves for the contingent environmental liabilities) to calculate surplus.

Section 174 of the DGCL provides that, where the corporation willfully or negligently repurchases stock or issues dividends where those distributions would exceed corporate surplus, the directors “under whose administration” the violation occurred “shall be jointly and severally liable to the corporation, and to its creditors in the event of its dissolution or insolvency, to the full amount unlawfully paid, with interest.” As Vice Chancellor Glasscock observed, Section 174 “appears to impose strict and several liability on any director vicariously for the negligence of another corporate actor as well as for her own negligence, and impose as damages the full amount paid out even if no actual harm to the corporate interest ultimately manifests itself.”

Section 172, on the other hand, provides that directors are “fully protected” from liability if they rely in good faith upon corporate records, officers, board committees, or other experts “as to the value and amount of the assets, liabilities and/or net profits of the corporation or any other facts pertinent to the existence and amount of surplus or other funds from which dividends might properly be declared and paid, or with which the corporation’s stock might properly be purchased or redeemed.” Vice Chancellor Glasscock enforced this provision, finding that Section 174 “must be read in conjunction with” Section 172.

Vice Chancellor Glasscock dismissed the case on demand futility grounds, finding that Plaintiffs had failed to plead specific facts that, if true, imply that the Director Defendants face a substantial likelihood of liability and would be disabled from assessing a demand to bring the claims on behalf of the corporation. In particular, Vice Chancellor Glasscock relied upon the fact that the Board discussed the environmental liabilities on several occasions, and Plaintiffs had not alleged particularized facts undermining the Board’s reliance on GAAP-based accounting in connection with its determinations that the stock repurchases and dividend payments complied with the DGCL. The Court also held that Section 172 could be considered at the pleading stage—and that the Board’s consultations with management and financial advisors (after receiving presentations about the environmental liabilities) established that they were “fully protected” under Section 172 from personal liability under Section 174.