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The Chancery Court recent decision in GB-SP Holdings LLC et al. v. Walker, (Del. Ch.; 11/24) provides a reminder that fiduciaries who breach their duty of loyalty may find themselves facing financial consequences even if damages to the company itself are too speculative to be proven.

The case involved claims of breach of fiduciary duty against the directors of BridgeStreet WorldWide, Inc. arising out of flawed efforts to restructure the financially troubled company’s debt.  After an unsuccessful effort to sell the company, a new creditor acquired its secured debt from existing creditors. BridgeStreet subsequently defaulted and entered into a forbearance agreement with the new creditor. During the negotiation process for that forbearance agreement, the company refused to honor its largest stockholder’s right under a shareholders’ agreement to have its designee elected to the board, and stiff-armed the stockholder’s information requests, which also violated the shareholders’ agreement.

The directors obtained indemnification from the creditor for any claims asserted by the company’s largest stockholder, and members of its senior management team, including two directors, secured continued employment and bonuses from the creditor as part of the forbearance agreement.  The company subsequently violated the financial covenants in the forbearance agreement, and ultimately agreed to a consensual foreclosure under which it surrendered all of the equity in its operating subsidiaries to the creditor.

The plaintiffs brought a derivative action, alleging that BridgeStreet and certain directors breached the shareholders agreement and that the directors breached their fiduciary duties in approving the forbearance agreement and the consensual foreclosure. The plaintiffs also brought claims against the creditor alleging that it aided and abetted the directors’ breach of fiduciary duty.

In addressing the breach of fiduciary duty claims, Vice Chancellor Fioravanti rejected the defendants’ contention that the decision to enter into the forbearance agreement was protected by the business judgment rule because the indemnity and employment arrangements established by the agreement involved self-interest.  Accordingly, he evaluated the decision to adopt the forbearance agreement under the entire fairness standard and found that neither the price nor the process were fair.  He also concluded that the creditor aided and abetted the breach of fiduciary duty.

While the Vice Chancellor concluded that the plaintiffs had not established more than nominal damages for their claims, he said that didn’t mean the defendants were off the hook. Citing Guth v. Loft, 5 A.2d 503, 510 (Del. 1939), he noted that “when a fiduciary has breached the duty of loyalty, the fiduciary must be deprived of all profit flowing from the breach. He then brought the hammer down:

While the harm to the Company is too speculative to quantify, the benefits to the Pre-Forbearance Directors are clear: each received indemnification for all claims brought by GB-SP, and Curtis and Worker received lucrative bonuses under the September 2013 MOU. The Pre-Forbearance Directors cannot retain the benefits they received as a result of their breaches of fiduciary duty. Therefore, the Pre-Forbearance Directors are liable to BSW for all amounts paid to them or their counsel under the Indemnity Agreement. In addition, the bonuses paid to Curtis and Worker under the September 2013 MOU must be disgorged and returned to BSW.

BridgeStreet still owed the creditor approximately $7 million, and as a remedy for its role in aiding and abetting the breach of fiduciary duty, Vice Chancellor Fioravanti held that its claims to any funds the company received from the disgorgement would be subordinated to the claims of other creditors.

– John Jenkins