The question of the legality of a dividend or repurchase under Delaware law is one that often arises in leveraged recaps and other transactions involving large distributions to shareholders. The answer usually depends on whether the company has sufficient “surplus” within the meaning of Section 154 of the DGCL. The Delaware Supreme Court has held that what matters in the surplus calculation is the present value of the company’s assets & liabilities, not what’s reflected on the balance sheet. Since that’s the case, valuations are often used to determine the amount of available surplus.
While that’s a pretty common practice, there’s not a lot of Delaware case law on how the board’s valuation decisions will be assessed. That’s kind of disconcerting, particularly since directors face the prospect of personal liability for unlawful dividends or stock repurchases. Fortunately, the Chancery Court’s recent decision in In re The Chemours Company Derivative Litigation, (Del. Ch.; 11/21), provides some guidance to boards engaging in this process. Here’s an excerpt from this Faegre Drinker memo on the decision:
In this case, the board approved both dividends and stock repurchases at a time when the company also faced legacy contingent environmental liabilities that conceivably could render Chemours insolvent.
The court deferred to the board’s determination that there was sufficient surplus to permit these transactions, even though the board looked beyond GAAP-metrics to evaluate its contingent liabilities. The court held that it “will defer to the Board’s surplus calculation ‘so long as [the directors] evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud.” This standard is consistent with the court’s prior guidance that the DGCL “does not require any particular method of calculating surplus, but simply prescribes factors,” total assets and total liabilities, “that any such calculation must include.”
As for reliance on experts, the court held that, under the DGCL, utilization of and good faith reliance on experts “fully protects” directors from personal liability arising from their surplus calculation. In reaching this conclusion, the court rejected the argument that the directors were required to second-guess the GAAP-based reserves calculated by the experts — an analysis that permitted the board to significantly reduce the size of these liabilities on Chemours’ balance sheet.
The memo goes on to provide some thoughts on the key takeaways from the decision, including the need for the board to carefully compile and review accurate data on assets & liabilities, and to retain an expert in any situation where the calculation of surplus may be an issue.
– John Jenkins