Officers of Selling Companies May Escape Fiduciary Duty Liability But May Be Required to Return Change of Control Payments if Company is Insolvent Post-Closing (Nine West Part 2)

While there has been much fuss over the recent ruling by the United States District Court for the Southern District of New York in In re Nine West LBO Securities Litigation¹ due to its potential ramifications for director liability, as we explored in Part I of our series on this case here, court watchers have paid less attention to the court’s treatment of officer liability and the interesting and important ways in which the court distinguished between liability for directors versus officers. Although officers may take some comfort from the court’s discussion of fiduciary duty liability, the decision highlighted a different type of risk officers may face in connection with a change of control transaction — the threat of having to return their change of control payments, which may be voided as fraudulent conveyances.

A brief recap of the facts (which are described in more detail in our original post): In 2014, the Jones Group engaged in a leveraged buyout (LBO) transaction, with private equity firm Sycamore Partners purchasing the company, and became Nine West. The LBO, which put substantial additional debt on the company, and related transfers of valuable assets out of Nine West shortly following the LBO ultimately led to Nine West’s bankruptcy a few years later. Garnering headlines, Judge Rakoff of the Southern District of New York ruled that directors of the Jones Group at the time of the LBO could be liable for breach of fiduciary duty under Pennsylvania law (and aiding and abetting the Nine West directors’ breaches of fiduciary duties under Delaware law) for failing to assess the post-sale solvency of the selling company, taking into account contemplated post-sale transactions, and that the business judgment rule would not apply in such situations.

Yet the ruling did not stop there, as the trustee for the litigation trust created under the chapter 11 plan (the “Litigation Trustee”) also went after the officers of the selling company. The Litigation Trustee alleged the same claims of breach of fiduciary duty and aiding and abetting a breach of fiduciary duty, as well as fraudulent transfer claims relating to the change of control payments the officers received due to the LBO. The court found that the officers could not be held to the same standard as the directors on a breach of fiduciary duty theory because the officers did not have the power to prevent the transaction. Similarly, the court determined that the officers could not be held liable on an aiding and abetting a breach of fiduciary duty theory because the officers provided merely tangential assistance to the approval of the LBO, unlike the directors, who were alleged to have provided substantial assistance.

The officers did not escape unblemished, however, as the court held that the fraudulent conveyance claims regarding the change of control payments made to the officers could proceed beyond the motion to dismiss stage. The court found that the complaint adequately alleged both a constructive fraudulent conveyance, because the company may have been insolvent at the time of the transfer, and an intentional fraudulent conveyance, as the plaintiff alleged details of the transfers with sufficient particularity and the complaint included allegations sufficient to support an inference of fraudulent intent.

This ruling highlights who has ultimate responsibility for the actions of companies and provides guidance as to how individuals in positions of responsibility ought to think about key decisions in the lifespan of a company. Those who are the final arbiters on decisions such as whether to engage in an LBO may face potential liability as to the post-sale solvency of the company, while those who cannot execute or influence a decision may not. Although the court here made a bright-line distinction between directors and officers, that may not always be the case.

In addition, the potential for change of control payments to be deemed fraudulent transfers may have the effect of causing officers to look more deeply into change of control transactions. While officers, unlike directors, may be able to avert fiduciary duty liability for misguided transactions that ultimately result in the company’s bankruptcy, the potential of having to return change of control payments in bankruptcy may serve as an incentive for officers to engage in more thorough due diligence prior to the consummation of a transaction.

A more detailed analysis of the court’s ruling is below, or readers can jump to the takeaway here.

Under Pennsylvania law, which governed the transaction because the Jones Group was a Pennsylvania corporation, officers owe a duty to act in good faith, in the best interests of the corporation, and with such care as an ordinary prudent person in similar circumstances.² Officers do not “owe fiduciary duties to a corporation regarding aspects of the management that are not within their responsibility or are within the exclusive province of the board,” but “may be held liable for breach of fiduciary duty to the extent that they have discretionary authority over, and the power...