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Hampshire Group Ltd. v. Kuttner, C.A. No. 360-VCS (Del. Ch. July 12, 2010) (Strine, V.C.)

July 12, 2010

In this memorandum opinion addressing the fiduciary duties of officers, the Court of Chancery found the defendant officers breached their fiduciary duty of loyalty by consciously causing the company to violate the law and certifying inaccurate financial statements.

Hampshire Group Limited, a clothing company, brought suit against two former officers, Charles Clayton (“Clayton”) and Roger Clark (“Clark”), alleging they breached their fiduciary duties by approving improper expense reimbursements for the company’s former CEO and founder, by knowingly causing the company to violate tax laws and by causing the company’s financial statements to be materially inaccurate. The company sued the officers and former CEO seeking to recover the costs associated with the investigation, additional tax liability, and the restatement of its financial statements and alleging breaches of fiduciary duty in connection with a number of matters. 

The company settled with the former CEO, who agreed to sell his 30% block of company stock to the company at a below market price and to pay approximately $1.5 million in cash. Shortly after that settlement, the two officers brought counterclaims against the company alleging, inter alia, defamation and breach of employment contract. Clayton also brought a third-party claim against certain board members and officers for contribution.

In discussing the appropriate standard of review for the company’s claims, the Court noted that, like directors, officers owe fiduciary duties of care and loyalty to the company. The Court confirmed that officers cannot be exculpated from monetary liability as permitted by DGCL § 102(b)(7). When considering the officers’ adherence to the duty of care, the Court applied a gross negligence standard. The Court assessed whether the officers’ actions comported with their duty of loyalty by considering all of the objective facts, including the professional and personal relationships between them and the former CEO, to determine whether they acted in bad faith for a purpose other than advancing the best interests of the company. The failure of an officer to inform superiors or principals of relevant material information would be evaluated under these same standards.

The Court found Clayton breached his duty of loyalty by consciously causing the company to violate the law by causing the company to reimburse a subsidiary’s executives for personal expenses. Clayton was also found to have breached his duty of loyalty by participating in and allowing to continue, after the company’s audit committee called a halt to it, a corporate donation program through which employees took personal deductions for donations made by the company. Both officers were found to have violated their fiduciary duty of loyalty by knowingly approving tuition payments on behalf of the former CEO’s assistant that were recorded as charitable donations. The Court also found the officers breached their fiduciary duty of loyalty by certifying to the integrity of the financial statements and internal controls for the periods in which they knew that the books of the company were false and that improper conduct had occurred, and by failing to inform the board of such misconduct. For those matters where the Court found the officers acted in good faith and were not grossly negligent, the Court found no breach of fiduciary duty. With respect to the company’s claim for recovery of bonuses paid, the Court rejected the company’s unjust enrichment theory and refused to create a strict liability rule in equity requiring officers to return bonuses any time there is a restatement. However, the Court found that the company was entitled to recoup a portion of the incentive bonuses paid to the officers based on a company policy, which the Court noted was a good example of a corporate claw back policy.

Preliminarily, the Court assessed damages against the officer defendants totaling approximately $297,242 (compared to the company’s claim of more than $6.3 million in damages) in connection with its investigation and financial restatements. Supplemental briefing was requested by the Court to address several issues raised during the trial and to address Clayton’s counterclaim for contribution.

With respect to the contribution counterclaim, for those issues for which Clayton was found liable, the Court found he could seek contribution only from the former CEO. In rejecting the company’s contention that § 3604 of the Delaware Uniform Contribution Among Tortfeasors Act does not apply to cases involving fiduciary misconduct, Vice Chancellor Strine commented that a court of equity would not permit a double recovery. The Court requested further briefing concerning the economic value of the settlement the company reached with the former CEO and whether that settlement should be credited against any judgment for the company. In addition, the parties were asked to compare the total monetary harm suffered by the company to the value of the settlement.

The full opinion is available here