A Third Way: Recovery of Excessive Executive Compensation as Disguised Unlawful Dividends

5 Min Read By: J. William Boone, Matthew M. Graham


  • Fraudulent transfer and fiduciary claims are the traditional tools that creditors use to seek recovery for excessive compensation paid to managers of insolvent companies.
  • However, creditors may also be able to characterize excessive compensation paid to manager-shareholders as disguised and unlawful dividends in certain jurisdictions.
  • Disguised unlawful dividend claims may have potential advantages over traditional fraudulent transfer and fiduciary claims depending upon the jurisdiction, including the inapplicability of business judgment rule protection, the unavailability of exculpation, and the ability to recover statutory interest.

Excessive executive compensation has come under fire in recent years from a range of commentators,[1] including surprising ones like former Chief Justice of the Delaware Supreme Court Leo Strine.[2] Although generous compensation packages may be justifiable in the case of a healthy company, in the case of a distressed company, they are more difficult to defend—economically and legally. For example, bankrupt OxyContin manufacturer Purdue Pharma recently disclosed that it paid its CEO Craig Landau $9 million in the 12 months before filing and doubled his salary in 2018 after hiring a law firm to provide bankruptcy advice.[3] Admittedly, it is not readily apparent that Landau’s compensation is excessive under current market standards. Even so, it is obvious that executives who receive outsized compensation packages and the board members who approve them are prime targets for dissatisfied corporate constituents, such as unpaid creditors, seeking to recoup value. Fraudulent transfer and fiduciary claims are the traditional tools that creditors use to seek recovery of excessive managerial compensation. However, in certain jurisdictions, creditors may also be able to characterize excessive compensation paid to manager-shareholders as disguised and unlawful dividends. As with other features of corporate law, the applicability and contours of the de facto dividend doctrine vary from jurisdiction to jurisdiction.

Sections 170(a) and 174(a) of the Delaware General Corporation Law (DGCL) make a director liable to the corporation, or its creditors in the event of insolvency, for the full amount of any illegal dividend, including those paid while “the corporation’s capital . . . is less than the capital represented by all outstanding shares having a preference upon the distribution of assets.”[4] In Horbal v. Three Rivers Holdings, Inc., minority shareholders in a health maintenance organization (HMO) sued corporate directors for “siphoning off tens of millions of dollars from the HMO in the form of disguised salaries, bonuses and corporate perquisites,” which the plaintiffs asserted were really “de facto dividends.”[5] Judge Chandler rejected plaintiffs’ theory on the ground that “[n]o Delaware court ha[d] ever recast executive compensation as a constructive dividend[.]”[6] Instead, Judge Chandler found that the plaintiffs’ claim implicated “a classic allegation of self-dealing or waste” subject to attack as a violation of the fiduciary duty of loyalty.[7]

Outside of Delaware, however, a number of courts have been willing to recast inordinate executive compensation as de facto, disguised, or constructive dividends,[8] particularly in the case of closely held corporations.[9] These claims may be brought by creditors or minority shareholders and can be framed as tort or statutory claims.[10] For example, in the recent case of Tisch v. Tisch, the Colorado Court of Appeals found that a controlling shareholder’s use of company funds from a family-owned liquor store for the payment of excessive salary, personal credit cards, and unauthorized loans qualified as disguised dividends supporting minority shareholders’ civil theft claim.[11]

From the perspective of an unpaid creditor, there are several potential advantages to recasting inordinate executive compensation as disguised and unlawful dividends, as opposed to pursuing only fiduciary duty or fraudulent transfer claims. First, as opposed to a fraudulent transfer claim, a director who is not a transferee may be held personally liable for authorizing or acceding to the unlawful dividend. In some jurisdictions, a director’s statutory liability for an unlawful dividend may be based upon mere negligence,[12] and the business judgment rule does not provide a defense.[13] Moreover, in certain jurisdictions, a director cannot assert the use of a special committee or exculpation language in a corporate charter as a defense to liability.[14] Additionally, in most jurisdictions, creditors may recover dividends paid while a company is insolvent from a manager-shareholder who received it with knowledge of the company’s insolvency.[15] Although this may be similar to an avoidable transfer claim, fraudulent transfer and preference defenses are unavailable because the statutory unlawful dividend claim is akin to a “strict liability” claim.[16] Finally, statutory unlawful dividend claims may also allow the plaintiff to recover interest from the date of the distribution.[17] Given these potential advantages over fraudulent transfer and fiduciary claims, practitioners advising boards and representing creditors should be aware of the possibility of courts recasting excessive executive compensation as disguised unlawful dividends in certain jurisdictions.

[1] J. William Boone is a partner at James-Bates-Brannan-Groover-LLP in Atlanta, Georgia, and Matthew M. Graham is a shareholder at Stearns Weaver Miller Weissler Alhadeff & Sitterson, P.A. in Miami, Florida.

[2] Leo E. Strine, Jr., Toward Fair and Sustainable Capitalism, Harvard John M. Olin Discussion Paper Series, Discussion Paper No. 1018 (Sept. 2019).

[3] Geoff Mulvihill & Tom Murphy, Purdue Pharma paid CEO $9M in year before bankruptcy, StarTribune, Oct. 30, 2019; Liz O. Baylen, Purdue Pharma workers can get bonuses, but maybe the CEO shouldn’t, judge decides, L.A. Times, Dec. 4, 2019.

[4] See Del. Code tit. 8, §§ 170(a), 174(a).

[5] CIV.A. 1273-N, 2006 WL 668542, at *1 (Del. Ch. Mar. 10, 2006).

[6] Id. at *3.

[7] Id. at *4; see also Quadrant Structured Prods. Co., Ltd. v. Vertin, 102 A.3d 155, 201 (Del. Ch. 2014).

[8] See, e.g., Tisch v. Tisch, 439 P.3d 89, 105 (Colo. App. 2019); Four Seasons Equip., Inc. v. White (In re White), 429 B.R. 201, 210 (Bankr. S.D. Tex. 2010); Interstate Highway Const., Inc. v. Gigot, 90-1289-K, 1990 WL 235693, at *2 (D. Kan. Dec. 20, 1990); Murphy v. Country House, Inc., 349 N.W.2d 289, 293 (Minn. Ct. App. 1984); Erdman v. Yolles, 233 N.W.2d 667, 669 (Mich. Ct. App. 1975).

[9] See Alaska Plastics, Inc. v. Coppock, 621 P.2d 270, 277 (Ala. 1980).

[10] Compare Interstate Highway Const., Inc., 1990 WL 235693, at *2 (statutory claim by creditor), with Tisch, 439 P.3d at 105 (civil theft claim by minority shareholders).

[11] See Tisch, 439 P.3d at 105 (Colo. App. 2019).

[12] Kan. Stat. § 17-6424; Okla. Stat. § 18-1053.

[13] See In re Musicland Holding Corp., 398 B.R. 761, 785 (Bankr. S.D.N.Y. 2008) (finding that section 174(a) of the DGCL “imposes a form of strict liability without regard to any action or inaction by a particular director” and “the business judgment rule does not apply because the payment of an unlawful dividend is an illegal act”).

[14] See 2 Model Bus. Corp. Act § 8.25 official cmt. (4th ed. 2013 rev.) (stating that “section 8.25(e)(1) generally makes nondelegable the decision whether to authorize or approve distributions, including dividends”); Del. Code tit. 8, § 102(b)(7) (providing that certificate of incorporation may not limit or eliminate a director’s personal liability for unlawful dividends under section 174 of the DGCL).

[15] See 12 Fletcher Cyc. Corp. § 5429 (2019).

[16] See In re Musicland Holding Corp., 398 B.R. at 785.

[17] See, e.g., Cal. Corp. Code § 316(d) (director liable for interest); Cal. Corp. Code § 506(a) (shareholder liable for interest).

By: J. William Boone, Matthew M. Graham

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