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Last Friday, in CIBC Bank v. Barker (Del. Ch.; 5/26), the Delaware Chancery Court addressed claims brought by a creditor after a failed sales process that resulted in an Article 9 sale “for pennies on the dollar.” The court held that the fiduciary duty claims were derivative, and the creditor plaintiff had standing, but dismissed them for failure to plead demand futility. The facts are as follows:

A PE fund invested over $25 million in BERA Brand Management’s preferred stock with a liquidation preference. It appointed two directors. BERA started in a financial decline at the time of this investment and soon breached a credit agreement covenant. Its creditor, CIBC, agreed to a forbearance agreement that gave the company a reasonable opportunity to sell substantially all of its assets. BERA hired a financial advisor and received some offers, but the board was deadlocked during the sales process. Some directors found all offers received to be too low and were divided over the purchase price allocation since it was insufficient to cover the PE investor’s liquidation preference.

Finally, after BERA was insolvent under the balance sheet test, CIBC gave notice that it was proceeding with an Article 9 sale. This also did not go well. While two offers were received, one materially higher than the other, BERA’s CEO contacted a bidder and threatened to divert key assets, undermining the process. Ultimately, the board notified CIBC that it voted to liquidate, and CIBC scheduled an Article 9 auction, which resulted in BERA paying only $650,000 of the over $7 million it owed CIBC.

CIBC filed suit against BERA, BERA’s current and former directors and the PE fund. It alleged that the directors breached their duties by bypassing “viable acquisition offers” seeking a higher valuation for the preferred stockholder’s liquidation preference and allowing the company’s CEO to sabotage a viable deal. Defendants argued that the creditor lacked standing to bring fiduciary duty claims directly and, if derivative, that demand was not excused.

Vice Chancellor Will found that “destroying the value of BERA by rejecting value-maximizing transactions is a ‘classically derivative’ injury to the corporation from corporate mismanagement.”

A creditor’s claims do not become direct simply because it suffered a harm secondary to the corporation’s. Since any injury to CIBC is “dependent on an injury” to BERA, the alleged harm is derivative in nature.

Claims of corporate mismanagement that destroy enterprise value are classically derivative because the corporation is the initial beneficiary of any recovery. Corporate insolvency, and the reality that a creditor may ultimately capture the recovered funds, does not transform a derivative claim into a direct one. Because CIBC’s claims center on BERA’s lost enterprise value, it cannot “prevail without showing an injury to the corporation.”

This meant that CIBC had standing (since a creditor of an insolvent corporation has standing to pursue derivative, but not direct, breach of fiduciary duty claims). But VC Will held CIBC to the usual pleading standard and found that it failed to meet its burden.

CIBC suggests that insolvency inherently compromises a director’s impartiality. It believes that such directors are less receptive to a demand “when the corporation’s financial condition has weakened its ability to provide indemnification and insurance.” Relatedly, CIBC asserts that directors of an insolvent corporation may have clouded judgment because they face the prospect of losing their roles. But Delaware law already accounts for these dynamics. If a director faces a substantial likelihood of personal liability on a non-exculpated claim and lacks indemnification, for example, that director will be deemed interested.

There is no ground—textual or equitable—for lowering the pleading standard when creditors pursue derivative claims. Rule 23.1’s requirements apply to any “derivative action” brought by any “derivative plaintiff.”

She found that CIBC had to plead “particularized facts supporting a reasonable inference that the directors acted disloyally or in bad faith to demonstrate that they face a substantial likelihood of liability,” and it did not do so for the demand majority. She dismissed its derivative claims for failure to plead demand excusal.

Delaware law does not require directors of an insolvent corporation to abandon efforts to maximize enterprise value simply because creditors stand to capture any incremental recovery. Even accepting that the Board wished to clear Peak’s liquidation preference to generate a return for junior stockholders, that goal aligns with maximizing BERA’s value. That BERA failed to close a going-concern sale and ultimately liquidated does not mean that the directors acted in bad faith when evaluating earlier proposals.

– Meredith Ervine