Judge opens door for bankruptcy blame suits

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When deals go bad and debt needs to be restructured, corporate directors often ask for a personal liability release. But they may need to be more careful about what to do next.

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Running news: A Delaware judge recently refused to quash breaches of fiduciary loyalty claims against three partners of private equity firm Wellspring Capital Management related to the ownership of a gun retailer that went bankrupt in 2019.

Backstory: Wellspring bought United Sporting Company in 2008, and later used a series of acquisitions to grow it under the Sportco name.

  • Concerns about meeting debt obligations began in 2017 and then, following a risky acquisition, Sportco was in potential breach by the end of 2018.
  • The directors asked for comprehensive D&O compensation as part of an out-of-court restructuring plan, but the lenders refused and the negotiations failed.
  • 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 breach of duty of care and loyalty.
  • The basic complaint is that Wellspring’s directors put their interests above those of the company and its creditors.
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big picture: Bankruptcy lawyers tell me that the Delaware judge’s ruling is the first to open the door for directors to sue for not accepting an out-of-court settlement, and could encourage lenders to deny liability waivers in the future.

  • While most directors and officers carry liability insurance, there are usually exclusions for intentional conduct or fraud.
  • Wellspring, which continues to invest in the 2018-vintage fund, did not return a request for comment.

Warning: The judge dismissed the claim for breach of fiduciary care, and is only allowing the loyalty claim to proceed – not to find that Wellspring’s partner is at fault on the facts.

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ICYMI: Richard Collings, who will be our up-and-coming writer axios pro Newspaper on retail deals, writes about Default fear is coming.

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