Jan 7, 2022 - Economy & Business

Judge opens door for bankruptcy blame suits

A gavel shattering a $100 bill

Illustration: Brendan Lynch/Axios

Corporate directors often ask for personal liability releases when deals go bad and debt needs to be restructured. But they may need to become much more careful about what they do next.

Driving the news: A Delaware judge recently refused to dismiss a breach of fiduciary loyalty claim against three partners of private equity firm Wellspring Capital Management, related to their ownership of a gun retailer that went bankrupt in 2019.

Backstory: Wellspring bought United Sporting Cos. in 2008, and used a series of acquisitions to grow what it later called SportCo.

  • Concerns about fulfilling debt obligations began in 2017 and then, following a risky acquisition, SportCo was in possible breach by late 2018.
  • The directors asked for comprehensive D&O indemnification, as part of an out-of-court restructuring plan, but the lenders declined and the talks collapsed.
  • SportCo went into default and filed for Chapter 11 bankruptcy protection in June 2019. Less than a year later, the liquidation trustee sued Wellspring and related parties, alleging breaches of fiduciary duty of care and loyalty.
  • The basic complaint is that Wellspring directors put self-interests above those of the company and its creditors.

The big picture: Bankruptcy lawyers tell me that the Delaware judge's ruling is the first to open the door for suing directors over not accepting an out-of-court settlement, and could embolden lenders to deny future liability waivers.

  • While most directors and officers do carry liability insurance, there are usually exclusions for willful conduct or fraud.
  • Wellspring, which continues to invest out a 2018-vintage fund, didn't return requests for comment.

Caveat: The judge did dismiss the claim for breach of fiduciary care, and this is only allowing the loyalty claim to proceed — not a finding that Wellspring partners are guilty on the facts.

ICYMI: Richard Collings, who will author our upcoming Axios Pro newsletter on retail deals, writes about coming default fears.

Go deeper